Arbitrage Restrictions on Tax-Exempt Bonds -- Temporary and Proposed Regulations Under Section 148

 [4830-01]

 ACTION: Temporary regulations.

 SUMMARY: This document contains temporary regulations relating to the arbitrage rebate requirements applicable to tax exempt bonds issued by States and local governments under section 103 of the Internal Revenue Code. Changes to the applicable law were made by the Tax Reform Act of 1986, the Technical and Miscellaneous Revenue Act of 1988, the Revenue Reconciliation Act of 1989, and the Revenue Reconciliation Act of 1990. The text of the temporary regulations set forth in this document also serves as the text of the notice of proposed regulations cross-referenced in the proposed rules section of this issue of the Federal Register.

 DATES: These regulations are effective April 25, 1991. Pursuant to section 1.148-0T(b), as added by T.D. 8252 and as amended in part by these temporary regulations, and section 1.103-13T(b), these temporary regulations are applicable to private activity bonds issued after December 31, 1985, and for bonds other than private activity bonds issued after August 31, 1986, except as provided in section 1.148-0T(b) as amended. Section 1.149-1T(d)(3) applies to bonds issued after May 28, 1991.

 FOR FURTHER INFORMATION CONTACT: William P. Cejudo, (202) 566-3283 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

This document amends the Income Tax Regulations (26 CFR part 1) promulgated with respect to sections 103, 148, and 149 of the Internal Revenue Code to simplify, clarify, and expand certain provisions of the temporary and proposed regulations sections 1.148-0T through 1.148-9T and section 1.149(d)-1T published in the Federal Register for May 15, 1989 (54 Fed. Reg. 20787 (1989)).

EXPLANATION OF PROVISIONS

A. REASONS FOR AND PURPOSES OF AMENDMENTS TO THE REGULATIONS.

Since their release in May, 1989, the arbitrage rebate regulations have been the subject of considerable commentary from both tax practitioners and government officials. A public hearing was held on the arbitrage rebate regulations on December 13, 1989. In addition, numerous written comments have been received from tax practitioners and governmental officials. The purpose of these amendments is to address some of the issues that have been raised with respect to the arbitrage rebate regulations and to make certain simplifying changes. It is anticipated that this regulatory project will be the first in a series of projects to amend the arbitrage rebate regulations. It is further anticipated that this series of future high priority regulatory projects on the arbitrage rebate regulations will include projects to address the two-year exception to the arbitrage rebate requirement for construction issues under section 148(f)(4)(C), the transferred proceeds rules for refundings under section 1.148-4T(e), and the general allocation and accounting rules for arbitrage rebate purposes under section 1.148-4T, and including particularly rules for commingled investments. The Internal Revenue Service invites further comments on these high priority projects.

B. MODIFICATIONS TO SECTION 1.148-1T - REQUIRED REBATE TO THE UNITED STATES.

1. COMPUTATION OF REBATE INSTALLMENT AMOUNTS (SECTION 1.148-1T(b)(1)(i)(A).

EXISTING REGULATIONS.

A rebate installment payment of 90 percent of computed rebatable arbitrage (determined as of a rebate installment computation date) must be paid to the federal government. For purposes of this 90 percent installment payment requirement, the existing regulations fail to take proper account of previous rebate installment payments. Thus, with respect to rebate installment computation dates occurring after the first rebate installment computation date, a rebate installment payment of 90 percent of the 10 percent unpaid rebatable arbitrage from the previous installment computation date must be paid.

For example, assume bonds were issued on January 1, 1990. On January 1, 1995 (the first rebate installment computation date), aggregate rebatable arbitrage of $100,000 was computed with respect to the bonds. As of January 1, 1995, a rebate installment payment of $90,000 (90 percent of $100,000) is due the federal government with respect to the first installment period. Assume that no rebatable arbitrage was earned during the period from January 1, 1995, through January 1, 2000, (the second rebate installment computation date). As of January 1, 2000, a rebate installment payment of $9,000 (90 percent of the $10,000 unpaid rebatable arbitrage from the first installment period) is due to the federal government with respect to the second installment period. Assume no rebatable arbitrage was earned during the period from January 1, 2000, through January 1, 2005, (the third rebate installment computation date). As of January 1, 2005, a rebate installment payment of $900 (90 percent of the $1,000 unpaid rebatable arbitrage as of the second rebate installment computation date) is due the federal government with respect to the third installment period. For purposes of this example, actual or deemed earnings on the $10,000 of unpaid rebatable arbitrage due after the first rebate installment computation date are ignored.

CHANGE.

One purpose of the 90 percent rebate installment payment requirement is to provide a cushion from installment period to installment period to allow an issuer to use later period earnings below the bond yield to offset earlier period earlier earnings above the bond yield to reach proper economic results. The 90 percent requirement should operate so that, as of a rebate installment computation date, the issuer will have paid 90 percent of all rebatable arbitrage it has earned since the date of issue of the bonds. In order to accomplish this result, amended section 1.148-1T(b)(1)(i) provides that, as of a rebate installment computation date, an issuer must pay to the federal government an amount that, when added to all previous rebate payments, equals 90 percent of the total rebatable arbitrage due on the issue (computed from the date of issue to the rebate installment computation date).

The effect of this amendment to section 1.148-1T(b)(1)(i) on the previous example is illustrated below. No rebate payment would be due with respect to the rebate amount computed as of the January 1, 2000, or the January 1, 2005, installment computation dates (disregarding actual or deemed earnings on the unpaid rebatable arbitrage). The total rebatable arbitrage computed as of the second installment computation date is $100,000 ($100,000 from the first installment period plus $0 from the second installment period). Ninety percent of $100,000 is $90,000. That amount less $90,000 rebatable arbitrage already paid with respect to the first installment period leaves $0 rebate due as of the second rebate installment computation date (again disregarding actual or deemed earnings on unpaid rebatable arbitrage). Similarly, no rebate would be due as of January 1, 2005, with respect to the third installment period. The $10,000 of remaining rebatable arbitrage, however, would be due 60 days after the bonds matured or were redeemed.

2. TAX EXEMPT STATUS OF REFUNDING ISSUE DEPENDENT ON COMPLIANCE OF REFUNDED ISSUE WITH REBATE REQUIREMENTS (SECTION 1.148-1T(b)(1)(ii)).

EXISTING REGULATIONS.

A refunding issue does not comply with the arbitrage rebate requirement if the refunded issue did not comply with the arbitrage rebate requirement.

CHANGE.

In order to simplify compliance with the arbitrage rebate requirement with respect to refunding bonds, this requirement is deleted, however, the refunded issue must still comply with relevant tax requirements.

3. ARBITRAGE EARNINGS ON FINAL PAYMENTS (SECTION 1.148-1T(b)(2)(iv)).

EXISTING REGULATIONS.

As of any rebate computation date (either an installment computation date or a final computation date), an issuer is required to calculate the rebatable arbitrage earned up to and including that date (the "rebate amount"). An issuer is allowed up to 60 days after the rebate computation date to pay the rebate amount calculated as of the rebate computation date. In the case of the final computation date, interest is imputed on the rebate amount for the period beginning on the final computation date and ending on the final rebate payment date (up to 60 days). The rebate amount plus this imputed interest is required to be paid to the federal government.

CHANGE.

The administrative complexity of this requirement outweighs the small financial benefit to the federal government of capturing, as rebate, this relatively small amount of investment earnings. Amended section 1.148-1T(b)(2)(iv) provides that imputation of earnings is not required if the final rebate payment is made within the 60-day period beginning on the final computation date. This amendment applies to investment earnings earned during the period beginning on the final computation date and ending on the date of payment of the rebate amount.

C. MODIFICATIONS TO SECTION 1.148-2T - COMPUTATION OF REBATABLE ARBITRAGE.

1. VARIABLE COMPUTATION DATE CREDIT (SECTION 1.148-2T(B)(4)).

EXISTING REGULATIONS.

A credit of $250 for bonds with an issue price of $1 million or less, $625 for bonds with an issue price greater than $1 million but less than $5 million, and $1,000 for bonds with an issue price greater than $5 million is allowed against rebatable arbitrage. No credit is allowed unless at least 75 percent of the net sale proceeds of the bonds have been spent on the project as of the rebate computation date.

CHANGE.

In order to simplify this provision, amended section 1.148-2T(b)(4) permits a single $3,000 credit for all bonds in lieu of the three separate credits. In addition, the requirement that at least 75 percent of the net sale proceeds be spent in order for bonds to be entitled to the credit is deleted. 2. Compounding interval for investment yield (section 1.148-2T(e)(4)).

EXISTING REGULATIONS.

A number of relatively complex rules determine the compounding period used in computing the yield on investments of gross proceeds. In certain circumstances, these rules may require a compounding interval for investment yield computation purposes different than the compounding interval for bond yield computation purposes.

CHANGE.

The purpose of the future value method is to compare yields on different investments using consistent compounding assumptions. The same compounding interval should be used for computing the yield on investments of gross proceeds and the yield on bonds. Amended section 1.148-2T(e)(4) requires that the compounding interval used to compute the yield on an investment be the same as the compounding interval used to compute the yield on the issue. Amended section 1.148-3T(b)(11) changes the rules prescribing the permitted compounding interval for purposes of computing bond yield.

D. MODIFICATIONS TO SECTION 1.148-3T -- COMPUTATION OF YIELD ON ISSUE.

1. BOND YIELD RECALCULATION FOR CERTAIN YIELD-TO-CALL BONDS (SECTION 1.148-3T(b)(4)(i)).

EXISTING REGULATIONS.

For purposes of computing bond yield, bonds are generally treated as called on a call date occurring prior to maturity if that treatment would result in a lower yield on the bonds (determined as of the date of issue of the bonds). A bond treated as called on a call date prior to its maturity is a yield-to-call bond. If a yield- to-call bond is not actually called on the call date that produces the lowest bond yield (determined as of the date of issue of the bonds), the bond is treated as being retired on that call date for the stated retirement price and then reissued on that date for a price equal to that retirement price.

CHANGE.

Under amended section 1.148-3T(c)(4), yield on most fixed yield bonds is calculated only once, as of the date of issue of the bonds. Amended section 1.148-3T(b)(4)(i) provides that yield is not recalculated for a fixed yield bond that is a yield-to-call bond and that meets the requirements of section 1.148-3T(c)(4) even if the bond is not called on the call date assumed for yield-to-call purposes.

2. EXCEPTION FOR ORIGINAL ISSUE PREMIUM ON CERTAIN YIELD-TO-CALL BONDS (SECTION 1.148-3T(b)(4)(ii)).

EXISTING REGULATIONS.

Any fixed yield bond that has a significantly lower yield attributable to an early call is generally treated as a yield-to-call bond.

CHANGE.

Amended section 1.148-3T(b)(4)(ii) provides two simplified mechanical exceptions to the definition of a yield-to-call bond. First, a bond that is not subject to redemption prior to maturity is not a yield-to-call-bond. Second, a bond that meets each of the following requirements is not a yield-to-call bond: (1) the bond is a fixed yield bond; (2) the stated rate of interest on the bond remains constant during its term; and (3) the amount of original issue premium on the bond does not exceed .25 percent multiplied by the number of years to the first call date of the bond. This second exception provides safe-harbor relief from the complex yield-to-call rules for fixed yield bonds (with no stepped coupons) with relatively insignificant amounts of original issue premium.

3. DEFINITION OF "RIGHT TO RETIRE" NOT TO INCLUDE UNSPENT PROCEEDS CALLS (SECTION 1.148-3T(b)(6)(ii)(B)).

EXISTING REGULATIONS.

The purpose of the "early retirement value" concept is to take into account the effect on bond yield of early retirement of bonds. The early retirement value concept generally applies when bond yield is required to be recomputed and the early retirement value is used to define the cash flows with respect to a bond to be taken into account in computing bond yield. For purposes of computing bond yield, the bond is treated as retired at its early retirement value (i.e., on the first call date that would result in the lowest yield on the bond). For purposes of determining early retirement value, the right to call bonds with unspent bond proceeds (an "excess proceeds call") is treated as a call date that must be taken into account. Under the early retirement concept, in a standard serial bond transaction, an excess proceeds call date may be treated as the maturity date of the bonds producing an artificially low yield on the bonds for arbitrage rebate purposes.

CHANGE.

Under amended section 1.148-3T(b)(6)(ii)(B), an excess proceeds call is generally not taken into account for purposes of determining the early retirement value of a bond. Bond yield recalculation is required in the event that significant excess proceeds are used to call bonds. Amended section 1.148-3T(c)(4) requires yield recalculation on fixed yield bonds in the event of certain significant excess proceeds calls.

4. EXCEPTION TO SPECIAL EARLY RETIREMENT VALUE RULE FOR CERTAIN ORIGINAL ISSUE DISCOUNT BONDS (SECTION 1.148-3T(b)(7)(iii)(C)).

EXISTING REGULATIONS.

There is no de minimis exception to the special early retirement value rule applicable to bonds subject to mandatory redemption that covers bonds issued with small amounts of original issue discount. In the case of many bonds with minimal amounts of original issue discount, therefore, complex yield calculations must be made to determine whether the special rule applies.

CHANGE.

New section 1.148-3T(b)(7)(iii)(C) provides a simplified mechanical exception under which a relatively small amount of original issue discount on a bond will not cause the bond to be subject to the special early retirement value rule. The rules in section 1.148-3T(b)(7)(iii)(A) and (B) pertaining to discount bonds apply to a bond issued with original issue discount only if: (1) the amount of discount is greater than .25 percent multiplied by the number of complete years to the final maturity date of the bonds; (2) the amount of discount is greater than .125 percent multiplied by the number of complete years to the final maturity date of the bonds and the first mandatory early redemption date of the bonds is more than 15 years before the final maturity date of the bonds; or (3) the amount of bonds subject to mandatory redemption on any date is more than 10 percent greater than the amount of bonds subject to mandatory redemption or payable at maturity on any later date.

5. SPECIAL RULES FOR CERTAIN EARLY REDEMPTIONS IN DETERMINING EARLY RETIREMENT VALUE (SECTION 1.148-3T(b)(7)).

EXISTING REGULATIONS.

The present definition of early retirement value does not permit an issuer to take into account redemption premium actually paid when recalculating bond yield.

CHANGE

New section 1.148-3T(b)(7)(iv) permits issuers to take into account premium actually paid on mandatory or optional redemptions made pursuant to the relevant bond documents and to take into account the accreted value of the bonds for open market purchases of bonds. In the event new section 1.148-3T(b)(7)(iv) applies, the early retirement value of the bond is as follows: (1) the actual redemption price of the bond (including call premium, if any) if the bond is redeemed pursuant to its terms (e.g., bonds called for redemption pursuant to the bond documents); or (2) the sum of the issue price of the bond plus accrued original issue discount determined under section 1288(a) if the bond is not redeemed pursuant to its terms (e.g., an open market purchase such as in a tender offer for the bonds).

 The following example illustrates the operation of this provision. Assume that the accreted value of a bond is 80 percent of par (80) but it is redeemed at par (100) pursuant to an optional redemption provision in the documents. The early retirement value is par (100). If the bond were purchased for par on the open market and retired when the accreted value was 80, however, the early retirement value would be 80.

6. COMPOUNDING INTERVAL FOR BOND YIELD (SECTION 1.148-3T(b) (11)).

EXISTING REGULATIONS.

An issuer is required to use the accrual period described in section 1272 as the compounding interval for determining bond yield. Section 1272(a)(5) defines the accrual period as the 6-month period (or shorter period from date of issue) ending on the day in the calendar year corresponding to the maturity date of the debt instrument or the date 6 months before such maturity date. Some issuers who desire to use the same compounding interval for multiple issues for administrative convenience have found the section 1272 accrual period definition to be inadequate.

CHANGE.

In order to provide issuers with maximum flexibility, amended section 1.148-3T(b)(11) permits the issuer to choose any compounding interval of not more than 1 year for purposes of computing yield on and the present value of a bond. Amended section 1.148-2T(e)(4) requires that issuers use the same compounding interval for purposes of determining the yield on investments and the yield on the bonds.

7. DETERMINATION OF A REASONABLE CHARGE WITH RESPECT TO A QUALIFIED GUARANTEE (SECTION 1.148-3T(B)(12)(iii)).

EXISTING REGULATIONS.

An issuer may take into account amounts paid for a "qualified guarantee" for purposes of computing yield on the issue. A guarantee is a qualified guarantee only if the present value of the payments for the guarantee is less than the present value of the interest expected to be saved as a result of the guarantee. Under section 1.148-3T(b)(12)(iii), the yield-to-maturity on the "bond" is to be used as the discount rate for purposes of determining the present value of the guarantee payments and the interest savings.

CHANGE.

Amended section 1.148-3T(b)(12)(iii) provides that the present value test is to be performed on the basis of the entire issue and the yield-to-maturity to be used for purposes of determining present value savings is the yield on the entire issue. This rule is consistent with the present value test for bond insurance in section 1.103-13(c)(8)(ii).

8. EXPANSION OF THE DEFINITION OF QUALIFIED GUARANTEES WITH RESPECT TO ELIGIBLE PURPOSE INVESTMENTS (SECTION 1.148-3T(b)(12)(viii)(B)).

EXISTING REGULATIONS.

Guarantees on "eligible purpose investments" may be taken into account for purposes of computing yield on the issue. The definition of an eligible purpose investment does not include an investment that has a yield higher than that permitted under section 1.103-13(b)(5)(i)(A) (i.e., .125 percent above bond yield).

CHANGE.

Amended section 1.148-3T(b)(12)(viii)(B) provides that investments eligible for a 1.5 percent yield over the bond yield as "acquired program obligations" under section 1.103-13(b)(5)(viii) may also qualify as eligible purpose investments.

9. SPECIAL RULE EXEMPTING FIXED YIELD ISSUES FROM YIELD RECALCULATION EXCEPT IN LIMITED CIRCUMSTANCES (SECTION 1.148-3T(c)(4)).

EXISTING REGULATIONS.

In the case of all but certain small issuers, an issuer of fixed rate bonds generally must recalculate yield on the bonds after the date of issue of the bonds if an event occurs that would change the bond yield. For example, if an issuer exercises an option to call the bonds prior to maturity, yield on the bonds must be recalculated taking into account the early call. If the issuer calculated bond yield as of the date of issue and restricted investments of the bond proceeds to that yield so as not to earn arbitrage and thereby avoid paying rebate, the recalculated (and most likely lower) bond yield may cause the issuer to pay an unanticipated rebate.

CHANGE.

Amended section 1.148-3T(c)(4) changes the general rule of yield calculation for "fixed yield issues" (i.e., fixed rate bonds) from a rule that yield recalculation is always required except in certain limited circumstances to a rule that yield recalculation is generally not required except under certain limited circumstances. Because of the possibility of yield recalculation, issuers currently may not rely on a calculation of bond yield performed as of the date of issue of the bonds. For those issues that meet the requirements of the new provision, bond yield is calculated only once as of the issue date.

 Amended section 1.148-3T(c)(4) applies to any fixed yield issue within the meaning of section 1.150-1T(b)(5)-(6) (but without regard to the transitional rule in section 1.148-3T(b)(3)(ii)). In general, the yield on a fixed yield issue is computed once as of the date of issue (or, in the case of conversion of an issue of variable rate bonds to a fixed rate, as of the first rebate computation date following conversion on which date the issue is first treated as a fixed yield issue), and no event occurring subsequent to the date of issue of a fixed yield issue is taken into account in computing the yield on a fixed yield issue. In two specified circumstances involving certain failures to spend a significant amount of original proceeds of bonds at any time or certain expected redemptions of bonds within the first five years, yield recomputation is required on a fixed yield issue.

E. MODIFICATIONS TO SECTION 1.148-4T -- ALLOCATION AND ACCOUNTING RULES.

EXISTING REGULATIONS.

Under section 1.148-4T(c)(2)(i), bond proceeds are not treated as spent by check on the date the check is written for purposes of the arbitrage rebate rules unless the check is delivered or mailed no later than one business day after the date it is written.

CHANGE.

The amended regulation addresses an issuer concern regarding the difficulty of determining whether a check is actually mailed within one business day and provides a liberalized rule. Amended section 1.148-4T(c)(2)(i) provides that bond proceeds are treated as spent on the date a check is written if the check is reasonably expected to be delivered or mailed no later than three business days after that date.

F. MODIFICATIONS TO SECTION 1.148-5T -- TRANSACTIONS GIVING RISE TO IMPUTED RECEIPTS.

1. SAFE HARBORS WITH RESPECT TO CERTAIN ACCOUNTS (SECTION 1.148-5t(b)).

EXISTING REGULATIONS.

If an issuer fails to invest bond proceeds or does not invest bond proceeds at arm's length, arbitrage diversion is possible. Existing section 1.148-5T(a) reserves the general rules on imputing earnings on bond proceeds. Existing section 1.148-5T(b) contains very complex safe-harbor rules that exempt issuers from imputing earnings on bond proceeds under certain circumstances.

CHANGE.

Amended section 1.148-5T(b) provides new safe harbors against imputation of earnings on bond proceeds. The new rules simplify the descriptions of accounts eligible for the safe harbors. A principal purpose of the general safe harbors is to recognize that bond proceeds may remain uninvested or invested at less than a market yield for legitimate, non-tax reasons. For example, it may be uneconomic or extremely inconvenient to invest large amounts of money for relatively short periods of time. In addition, it may be uneconomic to invest relatively small amounts of money.

 One new safe harbor focuses on the length of time that bond proceeds are not fully invested. This safe harbor provides that no investment earnings are imputed on certain uninvested amounts in an eligible account for a period of not more than three consecutive business days, not to exceed 20 days in the aggregate for any bond year.

 Another new safe harbor focuses on the average balance in an account. This safe harbor provides that no investment earnings are imputed on certain uninvested amounts in an eligible account during a bond year in which the average uninvested balance in the eligible account does not exceed $20,000. For purposes of computing average uninvested balance, an issuer may ignore amounts covered by the first safe harbor described in the preceding paragraph.

2. EXCESS TAX-EXEMPT RECEIPTS (SECTION 1.148-5T(C)(2)).

EXISTING REGULATIONS.

This provision prohibits the use of high yielding tax exempt bonds in an escrow for the purpose of earning arbitrage. In particular, certain excess earnings on tax exempt investments are allocated to taxable investments to prevent the use of tax exempt investments in an escrow to earn arbitrage.

CHANGE.

The above-described transaction amounts to a "device" and is more appropriately addressed under section 149. Existing section 1.148-5T(c)(2) is deleted, and new section 1.149(d)-1T(d)(3) addresses the abuse prohibited by this provision. These changes are effective for bonds issued after May 28, 1991.

G. MODIFICATIONS TO SECTION 1.148-8T -- DEFINITIONS AND SPECIAL RULES RELATING TO REQUIRED REBATE.

1. DETERMINATION OF BOND YEAR (section 1.148-8T(b)(2)).

EXISTING REGULATIONS.

The bond year ends on the last day of the compounding interval used in computing yield on the issue under section 1.148-3T.

CHANGE.

Amended section 1.148-8T(b)(2) permits issuers to choose any ending date for a bond year as long as that date is within one year of the date of issue of the bonds. This modification provides more flexibility for issuers who seek to use the same bond year for several different bond issues for administrative convenience. Conforming changes to sections 1.148-2T(e)(4) and 1.148-3T(b)(11) require that an issuer use the same compounding interval for computing yield on the bonds and yield on investments of gross proceeds of bonds.

2. ISSUE PRICE OF BONDS PUBLICLY OFFERED AT A DISCOUNT (SECTION 1.148-8T(c)(2)(ii)).

EXISTING REGULATIONS.

For a publicly offered bond, the issue price is the initial offering price to the general public and not the price paid by the underwriter. This is the same definition of issue price as is used in section 1273 and section 1274. A reasonable expectations test is used to determine the initial public offering price because, on the date of issue, the exact price at which the bonds subsequently will be sold to the general public may not be known. Substantially identical bonds offered at one price to the general public and at a discounted price to institutional or other investors must be separately identified for purposes of determining the issue price of each bond. Separate reasonable expectations as to offering prices of these separately identified bonds must be established. This type of discount for sales to institutional investors is commonly known as an underwriter's concession.

CHANGE.

Existing section 1.148-8T(c)(2)(ii) is deleted. Issuers and underwriters are no longer required or permitted to identify and segregate bonds expected to be publicly offered to the general public at one price from those publicly offered to institutions at a concession. This change is effective for bonds issued after May 28, 1991.

3. DEFINITION OF GROSS PROCEEDS (SECTION 1.148-8T(d)(3)).

EXISTING REGULATIONS.

Original proceeds are included within the definition of gross proceeds subject to arbitrage rebate under section 148. Excluded from the definition of original proceeds subject to rebate are certain administrative costs that are excluded from arbitrage yield restrictions (as contrasted with the arbitrage rebate requirements). In particular, excluded from the definition of original proceeds are certain administrative costs recoverable under sections 1.103-13(b)(5)(i)(A) and (c)(5). Under section 1.103-13(b)(5)(i)(A), an issuer is permitted to retain a yield spread of not more than .125 percent higher than bond yield on certain acquired obligations. Section 1.103-13(c)(5) permits certain administrative costs incurred with respect to acquired purpose obligations to be recovered in the yield on the acquired purpose obligations. Certain other similar costs or permitted yield spreads that are excluded from the arbitrage yield restrictions are not excluded from the definition of original proceeds subject to arbitrage rebate.

CHANGE.

In order to make the scope of the arbitrage rebate rules more consistent with the arbitrage yield restriction rules, amended section 1.148-8T(d)(3) adds to the previously described existing exclusions from the definition of original proceeds subject to arbitrage rebate those amounts attributable to the higher yields permitted under section 1.103-13(b)(5)(viii) and section 143(g)(2). Section 1.103-13(b)(5)(viii) permits a yield spread of not more than 1.5 percent higher than the bond yield for acquired program obligations. Section 143(g)(2) permits the yield on mortgage obligations acquired with proceeds of qualified mortgage bonds to exceed the yield on the bonds by not more than 1.125 percent.

H. MODIFICATIONS TO SECTION 1.148-9T -- CERTAIN RULES APPLICABLE FOR PURPOSES OF SECTION 148 GENERALLY.

EXISTING REGULATIONS.

There is no general anti-abuse rule similar to the "artifice or device" anti-abuse rule in section 1.103-13(j).

CHANGE.

In order to compensate for the deletion or dilution of some of the complex, specific anti-abuse rules in the arbitrage rebate regulations, new section 1.148-9T(g) makes the general arbitrage "artifice or device" anti-abuse rule in section 1.103-13(j) applicable for all purposes of section 148, including arbitrage rebate.

I. ADDITION TO SECTION 1.149(d)-1T -- RESTRICTIONS ON ADVANCE REFUNDINGS.

EXISTING REGULATIONS.

Section 1.149-1T reserves rules on prohibited abusive transactions in connection with advance refundings of tax exempt obligations.

CHANGE.

New section 1.149(d)-1T(d)(3) prohibits certain abuses in advance refundings involving escrows funded with both taxable and tax exempt obligations which inappropriately take advantage of the spread between long-term tax exempt obligations and short-term taxable obligations. In general, earnings on bond proceeds invested in tax exempt obligations are not treated as gross proceeds and are therefore not subject to rebate. An irrevocable defeasance escrow funded with proceeds of tax exempt advance refunding bonds generally is prohibited from containing investments with a composite yield in excess of the yield on the advance refunding bonds. Since, under section 148, investments in tax exempt bonds are deemed not to have a yield greater than the bonds, funding an escrow with long-term higher yielding tax exempt obligations and short-term taxable obligations would allow an issuer to earn a yield (based on the actual cash flows of the escrow) in excess of the advance refunding bond yield. New section 1.149-1T(d)(3) provides that an advance refunding bond will be treated as an abusive transaction under section 149(d)(4) if tax exempt investments are used inappropriately in an advance refunding escrow to earn arbitrage in the manner specified in the new regulation. New section 1.149-1T(d)(3) is effective prospectively.

J. CHANGES ANNOUNCED IN NOTICE 89-78.

EXISTING REGULATIONS.

In Notice 89-78, 1989-2 C.B. 390, the Internal Revenue Service announced that it would make certain specified changes to the existing arbitrage rebate regulations.

CHANGE.

This regulatory project incorporates all of the specified changes to the arbitrage rebate regulations announced in Notice 89-78, with one exception. Under this exception, this regulatory project does not incorporate the change described in paragraph 11 of Notice 89-78 that would require the determination of the issue price to take into account the discounted offering price for certain sales of bonds to institutional purchasers at a discount from the general public offering price. Instead, as previously described, this regulatory project deletes existing section 1.148-8T(c)(2)(ii).

K. ADDITION TO SECTION 1.103-13 -- ARBITRAGE BONDS.

EXISTING REGULATION.

The definition of original proceeds subject to yield restriction does not exclude certain amounts that are excluded from the definition of gross proceeds for arbitrage rebate purposes.

CHANGE.

To the extent that amounts are excludable from the broad definition of "gross proceeds" for arbitrage rebate purposes, such amounts generally should be excluded from the definition of "proceeds" for arbitrage yield restriction purposes. In order to increase the consistency between the arbitrage yield restriction rules and the arbitrage rebate rules, new section 1.103-13T clarifies that certain amounts excluded from the definition of original proceeds under section 1.148-8T(d)(3) are also excluded from the definitions of original proceeds and investment proceeds under section 1.103-13(b)(2). This change is consistent with the change to section 1.148-8T(d)(3).

SPECIAL ANALYSES

It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

The principal authors of these regulations are David A. Walton, Office of Tax Legislative Counsel, Department of the Treasury, and John J. Cross III, Office of the Assistant Chief Counsel (Financial Institutions & Products), Internal Revenue Service. However, other personnel from the Service and the Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR 1.61 - 1.281-4

 Deductions, Exemptions, Income Taxes, Reporting and recordkeeping requirements, Taxable income.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority for part 1 continues to read in part:

 Authority: 26 U.S.C. 7805 * * *

1. The introductory text of paragraph (b)(2)(ii)(B) is revised.

2. New paragraphs (b)(4) and (b)(5) are added.

3. Paragraph (d) is revised.

4. The added and revised provisions read as follows:

SECTION 1.148-0T SCOPE AND EFFECTIVE DATE OF RESTRICTIONS ON ARBITRAGE (TEMPORARY).

* * * * *

(b) * * *

(2) * * *

(ii) * * *

(B) * * * The provisions of sections 1.148-1T through 1.148-8T shall not apply, and the final rebate shall be considered timely paid, in the case of any bond that is part of an issue if -- * * *

* * * * *

(4) PROSPECTIVE EFFECTIVE DATE FOR CHANGE TO SPECIAL RULE REGARDING EXCESS TAX EXEMPT RECEIPTS. Section 1.148-5T(c)(2), as amended to reflect the removal of former section 1.148-5T(c)(2) as originally promulgated on May 15, 1989, applies to a bond issued after May 28, 1991. See section 1.149-1T(d)(3).

(5) PROSPECTIVE EFFECTIVE DATE FOR REMOVAL OF SPECIAL ISSUE PRICE RULE REGARDING CONCESSIONS. Section 1.148-8T(c)(2)(ii), as amended to reflect the removal of former section 1.148-8T(c)(2)(ii) as originally promulgated on May 15, 1989, applies to a bond issued after May 28, 1991.

(d) LIST OF SUBJECTS. This paragraph (d) lists the captioned paragraphs contained in sections 1.148-1T through 1.148-9T.

 SECTION 1.148-1T. REQUIRED REBATE TO THE UNITED STATES (TEMPORARY).

1. Paragraph (b)(1) is revised.

2. Paragraph (b)(2)(iv)(A) is revised.

3. Paragraph (b)(3)(ii)(C) is revised.

4. The revised provisions read as follows:

SECTION 1.148-1T REQUIRED REBATE TO THE UNITED STATES (TEMPORARY).

* * * * *

(b) REQUIRED REBATE -- (1) GENERAL RULE. An issue meets the requirements of this section if --

(i) REBATE INSTALLMENTS. An amount which, when added to all previous rebate payments made with respect to the issue, equals at least 90 percent of the sum of the rebatable arbitrage plus all previous rebate payments as of each installment computation date; and

(ii) FINAL REBATE. All of the rebatable arbitrage as of the final computation date and any income attributable to the rebatable arbitrage;

is paid to the United States in accordance with the requirements of paragraph (b)(3) of this section. See section 1.148-8T(b)(1) for definitions of installment and final computation date. See section 1.148-2T for computation of rebatable arbitrage. See paragraph (b)(2) of this section for income included in final rebate.

(2) * * *

(iv) * * *

(A) The amount described in paragraph (b)(2)(i) of this section is less than $300; or

* * * * *

(3) * * *

(ii) * * *

(C) The date 60 days after the earlier of the date the issuer no longer reasonably expects section 148(f)(4)(B) (relating to temporary investment exception) to apply to the issue, and the date 12 months after the date of issue.

* * * * *

Par. 4. Section 1.148-2T is amended to read as follows:

1. Paragraphs (b)(4)(ii) and paragraph (b)(4)(iii) are revised.

2. The second sentence of paragraph (c)(2) Example 1 (i) is revised.

3. Paragraphs (c)(2) Example 1 (iii) and (c)(2) Example 1 (iv) are revised.

4. The last sentence of paragraph (c)(2) Example 2 (i) is revised.

5. Paragraph (c)(2) Example 2 (ii) is revised.

6. Paragraph (c)(2) Example 3 is revised.

7. The second sentence of paragraph (e)(2)(i) is revised.

8. Paragraph (e)(2)(iii) is removed.

9. Paragraph (e)(4) is revised.

10. The revised provisions read as follows:

SECTION 1.148-2T COMPUTATION OF REBATABLE ARBITRAGE (TEMPORARY).

* * * * *

(b) * * *

(4) * * *

(ii) CREDIT AMOUNT. The computation date credit with respect to an issue on an eligible computation date is $3,000.

(iii) ELIGIBLE COMPUTATION DATE. For purposes of this paragraph (b)(4), a computation date is an eligible computation date unless that date is less than one year after the immediately preceding computation date (or the date of issue if that date is the first computation date).

* * * * *

(c) * * *

(2) * * *

EXAMPLE 1. (i) * * * As selected by City A, the compounding interval is each 6-month (or shorter) period ending July 1 and January 1, and the bond year is each 1-year (or shorter) period ending January 1. * * *

* * * *

(iii) The first installment computation date is January 1, 1992. See section 1.148-8T(b)(1)(ii). The yield on the issue is 7.000 percent per annum compounded semiannually (computed on a 30 day month/360 day year basis). The rebatable arbitrage as of the first installment computation date is $159,590.74, computed as follows:

 Date           Receipts (Payments)       FV (7.000 percent)

(iv) City A pays 90 percent of the rebatable arbitrage ($143,631.67) to the United States on February 28, 1992. City A redeems all the bonds on January 1, 1994. The final computation date is January 1, 1994. See section 1.148-8T(b)(1)(iii). The yield on the fixed yield issue is 7.000 percent per annum compounded semiannually. This yield is used to future value the receipts and payments from the date of issue to the final computation date. See paragraph (c)(1) of this section. The rebatable arbitrage as of the final computation date is $17,099.19, computed as follows:

 Date           Receipts (Payments)       FV (7.000 percent)

(ii) City A pays 90 percent of the rebatable arbitrage ($143,631.67) to the United States on February 28, 1992. The yield on the variable yield issue during the second yield period (the period beginning after the close of business on the first installment computation date and ending on the final computation date, 1/01/94) is 6.500 percent per annum compounded semiannually. This yield is used to future value the receipts and payments after the first installment computation date (1/01/92). See paragraph (c) (1) of this section. The rebatable arbitrage as of the final computation date is $16,781.98, computed as follows:

 Date           Receipts (Payments)    FV (7.000/6.500 percent)

 Receipts (Payments)

 Date            Receipts (Payments)   FV (7.000/7.500 percent)

 Receipts (Payments)

 Rebatable arbitrage:                       $22,467.12

 Date            Receipts (Payments)   FV (7.000/7.500 percent)

 Receipts (Payments)

 Receipts (Payments)

(e) * * *

(2) * * *

(i) * * * The yield on an investment that is allocated to an issue is the discount rate that produces the same present value when used in computing the present value of all the receipts received and to be received with respect to the investment, and the present value of all the payments with respect to the investment. * * *

* * * * *

(4) COMPOUNDING INTERVAL. For purposes of computing the present value of and yield on an investment, the compounding interval is the same as the compounding interval (as defined in section 1.148-3T(b)(11)) used in computing the yield on the issue.

* * * * *

Par. 5. Section 1.148-3T is amended to read as follows:

1. Paragraphs (b)(4)(i) and (b)(4)(ii)(A) and (B) are revised.

2. New paragraph (b)(4)(iii) is added.

3. The fourth sentence of paragraph (b)(5)(i) is removed.

4. Paragraph (b)(5)(iii) is revised.

5. Paragraph (b)(6)(ii)(B) is revised.

6. Paragraph (b)(7)(i) is revised.

7. New paragraphs (b)(7)(iii)(C) and (D) are added.

8. New paragraph (b)(7)(iv) is added.

9. Paragraph (b)(8)(ii)(A) is revised.

10. Paragraph (b)(10)(ii)(A) is revised.

11. Paragraph (b)(11) is revised.

12. Paragraphs (b)(12)(ii)(C)(2), (b)(12)(iii), (b)(12)(vi), and (b)(12)(viii)(B) are revised.

13. Paragraph (c)(4) is revised.

14. A sentence is added after the last sentence in paragraph (c)(7) Example 1(i).

15. The fourth and fifth sentences of paragraph (c)(7) Example 1 (ii) are revised.

16. Paragraph (c)(7) Example 1 (iii) is revised.

17. Paragraph (c)(7) Example 2 is revised;

18. Paragraph (c)(7) Example 4 (iv) is removed.

19. Paragraph (c)(7) Example 5 is revised.

20. The last sentence of paragraph (c)(7) Example 7 (ii) is revised.

21. Paragraphs (c)(7) Example 7 (iii) and (iv) are removed.

22. Paragraph (c)(7) Example 7 (v) is redesignated as paragraph (c)(7) Example 7 (iii).

23. The first sentence of newly designated paragraph (c)(7) Example 7 (iii) is revised.

24. The first sentence of paragraph (c)(7) Example 9 (ii) is revised.

25. The seventh sentence of paragraph (c)(7) Example 9 (iii) is revised.

26. Paragraph (d)(4) Example 3 (i) is revised.

27. A sentence is added after the second sentence in paragraph (d)(4) Example 9 (ii).

28. Paragraphs (d)(4) Example 9 (iii) and (d)(4) Example 9 (iv) are revised.

29. Paragraph (d)(4) Example 10 is revised.

30. The revised provisions read as follows:

SECTION 1.148-3T COMPUTATION OF YIELD ON ISSUE (TEMPORARY).

* * * * *

(b) * * *

(4) * * *

(i) IN GENERAL. A yield-to-call bond is treated as if the lowest yield date were the final maturity date and the stated retirement price on the lowest yield date were the stated retirement price on the final maturity date. If a bond to which the preceding sentence applies is not retired on or before the lowest yield date and an event described in section 1.148-3T(c)(4)(ii) or section 1.148-3T(c)(4)(iii) has occurred with respect to the bond, the bond is treated as if it were retired on that date for the stated retirement price on that date, and is treated as if issued on that date (as part of the same issue) for an issue price equal to that price (less any amount included in that price and paid to discharge principal or interest on that date). See paragraph (c)(7) of this section (Examples 4, 5, and 6) for fixed yield bonds and paragraph (d)(4) of this section (Example 3) for current index bonds.

(ii) * * *

(A) Any bond, other than a bond described in paragraph (b)(4)(iii) of this section, that is part of a fixed yield issue if the yield-to-maturity on the bond is more than one fourth of 1 percent higher than the lowest yield;

(B) Any fixed yield bond or current index bond, other than a bond described in paragraph (b)(4)(iii) of this section, that is part of a variable yield issue if the yield-to-maturity on the bond is more than one sixteenth of 1 percent higher than the lowest yield; and

* * * * *

(iii) EXCEPTIONS. A bond is not treated as a yield-to-call bond under this paragraph (b)(4), if --

(A) The bond is not subject to redemption prior to maturity, or

(B)(1) The bond is a fixed yield bond,

(2) The stated rate of interest on the bond remains constant during its term, and

(3) The excess of the issue price of the bond over the stated retirement price of the bond at maturity, stated as a percentage of the stated retirement price of the bond, is not greater than one fourth of 1 percent multiplied by the number of complete years to the first date on which the issuer or any ultimate obligor (or related person, as defined in section 147(a)(2)) has a right (under the terms of the bond or pursuant to a separate agreement or option entered into in connection with the issuance of the bond) to retire, redeem, or purchase the bond. For purposes of the preceding sentence, issue price and stated retirement price do not include accrued interest for a period of up to 6 months.

* * * * *

(5) * * *

(iii) LOWEST YIELD. The term "lowest yield" means, with respect to a bond, the yield on the bond determined by assuming the bond is retired on the lowest yield date for the stated retirement price on such date. For purposes of computing the lowest yield, the stated retirement price on the lowest yield date shall be treated as an unconditionally payable payment of principal and interest, and the lowest yield date is the date that when used in computing the yield on the bond produces the lowest yield.

(6) * * *

(ii) * * *

(B) RIGHT TO RETIRE. A person has a right to retire or redeem a bond as of a date even if the exercise of the right is subject to a contingency, provided that a right to redeem a bond only in the event of a remote contingency is not taken into account unless and until the remote contingency occurs. An example of a remote contingency is the destruction or condemnation of facilities financed with proceeds of the issue of which the bond is a part or, if the requirements of section 1.103-14(b)(1) are met as of the date of issue, the subsequent failure to spend proceeds of an issue.

(7) * * *

(i) IN GENERAL. Except as otherwise provided in this paragraph (b)(7), the early retirement value of a bond on any date is the lesser of --

(A) The present value of the bond on such date; and

(B) If the bond is part of a fixed yield issue (without regard to paragraph (b)(3)(ii) of this section) and the yield-to-maturity on the bond is higher than the lowest yield, the lowest stated retirement price (properly adjusted to take into account accrued interest) on any day during the period beginning one year before such date and ending 90 days after such date. See paragraph (c)(7) of this section (Examples 2, 4, 5, 7, and 9) for fixed yield bonds and paragraph (c)(4) of this section (Examples 1-3) for current index bonds.

* * * * *

(iii) * * *

(C) EXCEPTION FOR CERTAIN DISCOUNT BONDS. Notwithstanding anything to the contrary in paragraphs (b)(7)(iii)(A) and (B) of this section, this paragraph (b)(7)(iii) applies to a bond issued at discount only if --

(1) The amount of the discount is greater than one-fourth of 1 percent multiplied by the number of complete years from the date of issue to the final maturity date;

(2) The amount of discount is greater than one-eighth of 1 percent multiplied by the number of complete years from the date of issue to the final maturity date and the first mandatory early redemption date is more than 15 years before the final maturity date; or

(3) The amount of bonds subject to mandatory redemption on any date is more than 10 percent greater than the amount of bonds subject to mandatory redemption or payable at maturity on any later date.

(D) DETERMINATION OF DISCOUNT. The amount of discount is defined as the percentage obtained by dividing the excess of the stated retirement price over the issue price of a bond by the stated retirement price of the bond. For purposes of the preceding sentence, issue price and stated retirement price do not include accrued interest for a period of up to 6 months.

(iv) SPECIAL RULES FOR CERTAIN EARLY REDEMPTIONS. The early retirement value of a bond is the amount specified in paragraph (b)(7)(iv)(A) or (B) of this section if the bond is redeemed before the final maturity date and a recomputation of yield is required pursuant to section 1.148-3T(c)(4)(ii) or (iii).

(A) BOND REDEEMED PURSUANT TO ITS TERMS. In the case of a bond redeemed pursuant to its terms, the early retirement value is an amount equal to the actual redemption price of the bond (including call premium, if any).

(B) OTHER BONDS. For any redemption not described in paragraph (b)(7)(iv)(A) of this section, the early retirement value is an amount equal to the sum of the issue price for the bond, determined under section 1.148-8T(c), and the amount of accrued original issue discount, determined under section 1288(a).

(8) * * *

(ii) * * *

(A) IN GENERAL. For purposes of computing the present value of a bond, the yield-to-maturity on the bond shall be used as the discount rate, and the bond shall be assumed to be retired on the final maturity date for the stated retirement price on such date.

* * * * *

(10) * * *

(ii) * * *

(A) IN GENERAL. A payment of principal or interest on a bond is unconditionally payable if the amount of the payment and the date the amount is actually and unconditionally due are fixed and determinable as of the date of issue (determined by assuming that no payment is paid before the latest date the payment is actually and unconditionally due). A payment shall not be treated as unconditionally payable to the extent that it is not reasonably certain on the date of issue of the bond that the payment actually will be paid.

* * * * *

(11) ISSUE. -- (i) BOND. The compounding interval used in computing the yield on and the present value of a bond is the compounding interval used with respect to each bond that is part of the issue.

(ii) ISSUE. The compounding interval used in computing the yield on an issue and the present value of amounts under paragraphs (c)(1) and (d)(1) of this section is any compounding interval of not more than one year that is used with respect to each bond that is part of the issue.

(12) * * *

(ii) * * *

(C) * * *

(2) An entity that is not exempt from Federal income taxation and that is a bank (within the meaning of section 581 or 585(a)(2)(B)), is rated in one of the two highest (e.g., "AA," "AAA," "Aa," or "Aaa") categories for unsecured debt or insurance underwriting or claims paying ability by a nationally recognized rating agency, or by issuing its policies causes obligations insured thereby to be rated in one of the two highest categories; and

* * * * *

(iii) REASONABLE CHARGE. A guarantee of a bond does not meet the requirements of this paragraph (b)(12) if the payments for the guarantee of the bond exceed a reasonable charge for the transfer of credit risk. In determining whether this requirement is met, there shall be taken into account payments charged by guarantors in comparable transactions (including transactions in which the guarantor has no involvement other than as guarantor). In no event will this requirement be considered met unless the present value of the guarantee payments on the issue is less than the present value of the interest expected to be saved on the issue as a result of the guarantee. Present value is computed by using the yield-to-maturity on the issue (with regard to payments for the guarantee) as the discount rate.

* * * * *

(vi) WHEN PAYMENTS COINCIDE. For purposes of paragraph (b)(12)(v)(A) of this section, payments on a purpose investment and a bond coincide if --

(A) The payments are actually and unconditionally due during the same compounding interval used in computing the yield on the bond, determined by taking into account only payments of interest on the bond;

(B) The payments are actually and unconditionally due during the same compounding interval used in computing the yield on the bond, determined by taking into account only payments of principal on the bond; or

(C) The payments on the bond are actually and unconditionally due no later than one month after the payments on the purpose investment.

In applying this paragraph (b)(12)(vi) to an issue, there shall not be taken into account any discrepancy of no more than one month, or any amount less than $250,000 that is required to be used to redeem bonds no later than the first available call date.

* * * * *

(viii) * * *

(B) The yield on the investment is not reasonably expected to be materially higher than the yield on the issue (within the meaning of section 1.103-13(b)(5)(i)(A), or, in the case of investments in acquired program obligations, within the meaning of section 1.103-13(b)(5)(viii)) but determined --

* * * * *

(c) * * *

(4) SPECIAL RULE REGARDING FREQUENCY OF YIELD COMPUTATIONS ON FIXED YIELD ISSUES -- (i) GENERALLY NO YIELD RECOMPUTATION. In general, no event occurring subsequent to the date of issue of a fixed yield issue (without regard to paragraph (b)(1)(ii) of this section) is taken into account in computing the yield on a fixed yield issue. Except for any yield adjustment to account for an event described in paragraph (c)(4)(ii) or (c)(4)(iii) of this section, the yield on a fixed yield issue is the yield on the issue determined by treating the date of issue (or for an issue treated as a fixed yield issue under section 1.148-3T(b)(3)(ii), the computation date on which it was first treated as a fixed yield issue) as the only computation date.

(ii) RECOMPUTATION OF YIELD IN CASE OF FAILURE TO SPEND PROCEEDS. The yield on a fixed yield issue is adjusted to take into account the retirement of any bonds that are part of the issue (whether by redemption, purchase, or otherwise) prior to their final maturity date or scheduled early retirement date with original proceeds of the issue if the cumulative aggregate amount of original proceeds used for this purpose exceeds 25 percent of the original proceeds of the issue.

(iii) RECOMPUTATION OF YIELD IN CASE OF CERTAIN EARLY REDEMPTIONS. The yield on a fixed yield issue is adjusted to take into account the following events:

(A) The retirement (other than with original proceeds of the issue) of any bond that is part of the issue (whether by redemption, purchase, or otherwise) prior to its final maturity date or scheduled early retirement date and prior to the date that is 5 years from the date that the issue is first treated as a fixed yield issue; or

(B) The expected retirement of any bond that is part of the issue (whether by redemption, purchase, or otherwise) prior to its final maturity date or scheduled early retirement date if prior to the date that is 5 years after the date that the issue is first treated as a fixed yield issue, cash or nonpurpose investments (other than original proceeds of the issue) have been deposited into a fund that is reasonably expected to be used for that early retirement, or the issuer has contractually obligated itself to carry out that early retirement, regardless of whether that early retirement actually occurs.

For purposes of this paragraph (c)(4), amounts derived by an issuer from a purpose investment are not treated as original proceeds of an issue, unless such amounts are derived from amounts originally lent or otherwise advanced by the issuer to the conduit obligor under the purpose investment or earnings thereon that have not been expended by the conduit obligor for the governmental purpose of the issue. See paragraph (c)(7) of this section (Examples 1, 2, 3, 6, 8, and 10).

* * * * *

(7) * * *

EXAMPLE 1. (i) * * * All of the proceeds of the bonds are spent within three years.

(ii) * * * The bonds are not yield-to-call bonds because the yield-to-maturity on the bonds (9.983 percent, the same as the yield on the issue to maturity computed above) is not more than one fourth of one percent higher than the lowest yield on the bonds (9.979 percent, the same as the yield on the issue to the first par call date computed in subdivision (iii) below), and because the issue price of the bonds is not higher than the stated redemption price at maturity. See paragraphs (b)(4)(ii)(A), (b)(4)(iii)(B), (b)(5)(ii), and (b)(5)(iii) of this section.

(iii) All the bonds are redeemed on July 1, 1995, at par plus accrued interest ($22 million). Because all bond proceeds were expended and the redemption of the bonds took place after the first installment computation date, no recomputation of the yield is required, and the yield on the bonds is 9.983 percent. See paragraph (c)(4)(i) of this section.

EXAMPLE 2. The facts are the same as in Example 1, except that all the bonds are retired on September 15, 1991, for $17.5 million. Since the bonds are retired other than pursuant to their terms, the aggregate early retirement value of the bonds on September 15, 1991, is the issue price of the bonds, plus any accrued original issue discount. See paragraph (b)(7)(iv)(A) of this section. The aggregate early retirement value of the bonds is par plus accrued interest ($20,411,111.11). The yield on the issue as of the final computation date (9/15/91) is 9.982 percent per annum compounded annually, computed as follows:

 Date             Issue Payments         PV(9.98208583 percent)

* * * * *

EXAMPLE 5. The facts are the same as in Example 4, except that the 2003 bond is retired from monies other than bond proceeds on July 1, 2000, and the 2008 bond is retired from monies other than bond proceeds on July 1, 2001. Even though the 2003 bond is outstanding after the lowest yield date (7/01/98), the 2003 bond nonetheless is treated as if it were retired for $10.8 million on July 1, 1998 (the stated retirement price on such date). See paragraph (b)(4)(i) of this section. No adjustment to the yield on the issue is made to reflect the fact that the 2003 bond remained outstanding beyond the lowest yield date. Since the retirement of the 2003 and 2008 bonds occurred after the first installment computation date, the yield on the issue remains 8.554 percent per annum, compounded annually. See paragraph (c)(4) of this section.

* * * * *

EXAMPLE 7. * * *

(ii) * * * See paragraph (iii) of this example.

(iii) The special rule in paragraph (b)(7)(iii)(A) of this section for determining the early retirement value of certain discount bonds did not apply to the bonds, because the yield-to- maturity on the bonds is not more than one fourth of 1 percent lower than the composite yield-to-maturity determined as provided in paragraph (b)(8)(ii)(8) of this section (7.085 percent), and because the bond qualifies under the exception provided in paragraph (b)(7)(iii)(C) of this section. * * *

* * * * *

EXAMPLE 9. * * *

(ii) The special rule in paragraph (b)(7)(iii)(A) of this section for determining the early retirement value of the bonds applies to the bonds, because the yield-to-maturity on the bonds is more than one fourth of 1 percent lower than the composite yield-to-maturity determined as provided in paragraph (b)(8)(ii)(B) of this section, and because the bonds do not meet the provisions in paragraph (b)(4)(iii) of this section. * * *

(iii) * * *

See paragraph (c)(2)(i), (c)(2)(iii), (c)(2)(iv), and (c)(3)(ii) of this section. * * *

* * * * *

(d) * * *

(4) * * *

* * * * *

EXAMPLE 3. (i) The facts are the same as in Example 2, except that the bonds are subject to optional redemption at par plus accrued interest on December 1, 1990. County C spent all the proceeds of the issue before that date.

* * * * *

EXAMPLE 9. * * *

(ii) * * * All the proceeds of the bonds are expended by that date. * * *

(iii) All the bonds are outstanding on the second installment computation date (9/01/98). The issue is treated as a fixed yield issue issued as of the first day of the second yield period (9/01/93), and each fixed yield bond that is part of the issue is treated as if issued after the close of business on such date for an issue price equal to the outstanding par amount of the bond on such date. See paragraphs (b)(3)(ii), (b)(7)(i), (b)(8)(i), (b)(8)(iii), and (d)(3)(ii) of this section. The yield on the fixed yield issue as of the second installment computation date is 8.338 percent per annum compounded semiannually, computed as follows:

 Date       Debt Service      Guarantee     PV (8.338 percent)

(iv) All the bonds are redeemed on September 1, 2000, at 103 percent of par ($25,750,000) plus accrued interest ($2,125,000). The yield on the fixed yield issue as of the final computation date (9/01/00) is 8.338 percent per annum compounded semiannually.

EXAMPLE 10. The facts are the same as in Example 9, except that all the bonds are retired on March 1, 1997, at par. Because the bonds are retired on a date (3/01/97) that is less than five years from the date on which the issue was first treated as a fixed yield issue (9/01/93), the yield on the issue must be recomputed. See paragraph (c)(4)(iii) of this section. The yield on the fixed yield issue as of the final computation date (3/01/97) is 8.330 percent per annum compounded semiannually, computed as follows:

 Date       Debt Service      Guarantee     PV (8.338 percent)

Par. 6. Section 1.148-4T is amended to read as follows:

1. Paragraph (c)(2) is revised.

2. The last of sentence of paragraph (e)(1)(iii) is revised.

3. The first and last sentences of paragraph (e)(2)(ii)(C) are revised.

4. A sentence is added after the last sentence in paragraph (e)(2)(ii)(C).

5. Paragraph (e)(2)(ii)(D) is revised.

6. New paragraph (e)(3) is added.

7. The added and revised provisions read as follows:

SECTION 1.148-4T ALLOCATION AND ACCOUNTING RULES (TEMPORARY).

* * * * *

(c) * * *

(2) EXPENDITURES FROM CHECKING ACCOUNT. An expenditure of proceeds in a checking or similar account may be treated as made --

(i) On the date a negotiable check is written on the account if the check is reasonably expected to be delivered or mailed no later than three business days after that date; or

(ii) On the date the check is delivered or mailed; if the payor has no reason to believe that the check will not clear within a reasonable period of time thereafter.

* * * * *

(e) * * *

(1) * * *

(iii) * * *

Any amount that was part of a bona fide debt service fund for the refunded issue shall be treated as described in paragraph (e)(1)(iii)(B).

* * * * *

(2) * * *

(ii) * * *

(C) * * * In the case of a refunding issue to which section 149(d)(4) applies, paragraph (e)(2)(i) of this section shall not apply on a date to the extent that it would cause the value of the nonpurpose investments allocated to the refunding portion of the issue to exceed the value of the bonds allocated (on a pro rata basis) to such portion of the issue. * * * For purposes of this paragraph (e)(2)(ii)(C), tax-exempt investments shall not be treated as tax-exempt, and investments allocated to gross proceeds (other than proceeds) shall not be treated as nonpurpose investments. If the refunding portion of the refunding issue refunds more than one refunded issue, the portion that refunds each refunded issue shall be treated as a separate issue for purposes of applying this paragraph (e)(2)(ii)(C).

(D) NO TRANSFER IN ABUSIVE CASES. Paragraph (e)(2)(i) of this section shall not apply to proceeds allocated to investments to the extent that the principal purpose for issuing any portion of the refunding issue is to cause such investments to cease to be allocated to the refunded issue (or to become allocated to the refunding issue). For purposes of applying the preceding sentence to investments in a restricted escrow, the purpose of restructuring debt service shall not be taken into account.

* * * * *

(3) SEPARATE ISSUE TREATMENT FOR CONDUIT FINANCINGS -- (i) IN GENERAL. The portion of a refunded issue properly allocated to a conduit purpose investment shall be treated as a separate issue for purposes of applying paragraphs (e)(1) and (e)(2) of this section.

(ii) CONDUIT PURPOSE INVESTMENT. The term "conduit purpose investment" means any purpose investment if --

(A) The purpose investment is an eligible purpose investment (within the meaning of section 1.148-3T(b)(12)(viii); and

(B) The purpose investment meets the requirements of section 1.148-3T(b)(12)(v) (or could meet such requirements if the purpose investments were guaranteed).

Par. 7. Section 1.148-5T is amended to read as follows:

1. Paragraph (b) is revised.

2. Paragraph (c)(2) is removed.

3. Paragraph (c)(3) and (c)(4) are redesignated as (c)(2) and (c)(3).

4. The last sentence of newly designated paragraph (c)(3) Example 1 (i) is revised.

5. The revised provisions read as follows:

SECTION 1.148-5T TRANSACTIONS GIVING RISE TO IMPUTED RECEIPTS (TEMPORARY).

* * * * *

(b) SAFE HARBOR TO AVOID IMPUTATION OF INVESTMENT EARNINGS -- (1) IN GENERAL. No investment earnings are imputed with respect to:

(i) TIME. Any uninvested amount contained in an eligible account for a period of not more than three consecutive business days, not to exceed in the aggregate 20 days in any bond year.

(ii) AVERAGE UNINVESTED BALANCE. Any uninvested amount contained in an eligible account during a bond year in which the average uninvested balance contained in the eligible account does not exceed $20,000.

(2) DEFINITIONS -- (i) UNINVESTED AMOUNT. An uninvested amount is an amount of gross proceeds that is uninvested, invested in a manner so that actual investment earnings cannot be determined (e.g., unintentionally lost or stolen records), or invested in a non- interest bearing demand or trust account.

(ii) AVERAGE UNINVESTED BALANCE. For any bond year, the average uninvested balance for any account is the sum of the uninvested amounts as of the close of each day in the bond year divided by the number of days in the bond year. For purposes of this paragraph (b)(2)(ii), any uninvested amount described in paragraph (b)(1)(i) of this section is not taken into account.

(iii) ELIGIBLE ACCOUNT. An eligible account is an account or fund containing gross proceeds of an issue meeting the following requirements:

(A) An eligible account cannot be created or availed of for the purpose of minimizing rebatable arbitrage.

(B) An eligible account must be consistent with the customary recordkeeping requirements and practices of its owner.

(C) Not more than 4 eligible accounts are permitted for any single owner with respect to any single bond issue.

(D) The issuer may not expect to receive a direct or indirect benefit from uninvested amounts on deposit in an eligible account. Neither the owner of the eligible account nor any agent or officer of the owner may enter into any arrangement, formal or informal, designed to give the owner (or its designee) any benefit as a result of uninvested amounts on deposit in the eligible account.

(E) For purposes of this section, two or more accounts or funds may at the option of the owner or owners be considered to be a single account so long as all amounts contained in the funds or accounts are gross proceeds of the same issue.

(c) * * *

(3) * * *

EXAMPLE 1. (i) * * * See paragraph (c)(2) of this section.

* * * * *

Par. 8. Section 1.148-8T is amended to read as follows:

1. Paragraph (b)(2) is revised.

2. The fourth sentence of paragraph (c)(1) is removed.

3. Paragraph (c)(2)(ii) is removed.

4. Paragraph (c)(2)(iii) is redesignated as (c)(2)(ii) and is revised.

5. Paragraph (c)(2)(iv) is redesignated as (c)(2)(iii).

6. Paragraph (d)(3) is revised.

7. The revised provisions read as follows:

SECTION 1.148-8T. DEFINITIONS AND SPECIAL RULES RELATING TO REQUIRED REBATE (TEMPORARY).

* * * * *

(b) * * *

(2) BOND YEAR. The term "bond year" means, with respect to an issue, each 1-year period (or shorter period from the date of issue) that ends at the close of business on the day in the calendar year that is selected by the issuer. If no day is selected by the issuer before the earlier of the final maturity date of the issue or the date that is 5 years after the issue date, each bond year ends at the close of business on the day preceding the anniversary of the issue date.

* * * * *

(c) * * *

(2) * * *

(ii) BONA FIDE OFFERING REQUIRED. Paragraph (c)(2)(i) of this section does not apply to any bond that is not actually offered to the general public in a bona fide public offering for the issue price of the bond (determined without regard to this sentence).

* * * * *

(d) * * *

(3) ORIGINAL PROCEEDS. The term "original proceeds" means, with respect to an issue, any sale proceeds and any investment proceeds of the issue. The term also includes any amount recovered with respect to the issue under section 1.148-1T(d). The term does not include amounts actually or constructively received with respect to a purpose investment to the extent those amounts are properly allocated to administrative costs recoverable under section 1.103-13(c)(5) or to the higher yield permitted under section 1.103-13(b)(5)(i) section 1.103-13(b)(5)(viii), or section 143(g)(2). For purposes of the preceding sentence, a purpose investment that is a tax exempt bond is not treated as tax exempt.

* * * * *

Par. 9. Section 1.148-9T is amended to read as follows:

1. Paragraph (g) is redesignated as paragraph (h) and is revised.

2. New paragraph (g) is added.

3. The revised provision reads as follows:

SECTION 1.148-9T CERTAIN RULES APPLICABLE FOR PURPOSES OF SECTION 148 GENERALLY (TEMPORARY).

* * * * *

(g) ARTIFICE OR DEVICE. Section 1.103-13(j) applies for purposes of section 148 generally, including for purposes of the calculations of yield, expenditures, and investment earnings under section 148(f). For purposes of section 1.103-13(j), enabling the issuer to retain significant additional rebatable arbitrage constitutes a "material financial advantage."

(h) EFFECTIVE DATE -- (1) IN GENERAL. Except as otherwise provided in this paragraph (h), the provisions of this section apply to any issue sold after May 15, 1989, or issued after June 14, 1989.

(2) COMPUTATION OF YIELD ON INVESTMENTS. Paragraph (b) of this section may be applied in the case of any issue to which section 1.148-1T applies that is not described in paragraph (h)(1) of this section.

(3) INVESTMENT PROPERTY. Paragraph (f) of this section shall apply to any bond that is not described in paragraph (h)(1) of this section to the same extent that section 148(b)(2) applies to such bond.

Par. 10. Section 1.149(d)-1T is amended by adding paragraph (d)(3) to read as follows:

SECTION 1.149(d)-1T. RESTRICTIONS ON ADVANCE REFUNDINGS (TEMPORARY).

* * * * *

(d) * * *

(3) MIXED ESCROWS -- (i) IN GENERAL. Any issue any portion of which is a bond that is an advance refunding bond described in section 149(d)(5) is an issue described in section 149(d)(4) if --

(A) Any of the proceeds of the issue are invested in an advance refunding escrow in which a portion of the proceeds are invested in tax exempt bonds (within the meaning of section 1.148-8T(e)(3)) and a portion of the proceeds are invested in nonpurpose investments;

(B) The yield on the tax exempt bonds in the advance refunding escrow exceeds the yield on the bonds;

(C) The yield on all the investments (including investment property and tax exempt bonds) in the advance refunding escrow exceeds the yield on the bonds; and

(D) The weighted average maturity of the tax exempt bonds in the advance refunding escrow is more than 25 percent greater or less than the weighted average maturity of the nonpurpose investments in the advance refunding escrow, and the weighted average maturity of nonpurpose investments in the advance refunding escrow is greater than 60 days.

(ii) ESCROW. For purposes of this section 1.149(d)-1T(d)(3), an advance refunding escrow means an advance refunding escrow as defined in section 1.148-8T(g), except that investments in the escrow may include both nonpurpose investments and tax exempt bonds.

(iii) EFFECTIVE DATE. This paragraph (d)(3) applies to any bond issued after May 28, 1991, if any bond issued as part of the issue (of which such bond is a part) is issued to advance refund another bond (within the meaning of section 149(d)(5).

Par. 11. The following new section 1.103-13T is added to read as follows:

SECTION 1.103-13T EXCLUSIONS FROM THE DEFINITIONS OF ORIGINAL PROCEEDS AND INVESTMENT PROCEEDS (TEMPORARY).

(a) IN GENERAL. For purposes of section 1.103-13(b)(2) and notwithstanding contrary definitions, those amounts excluded from the definition of "original proceeds" that is contained in section 1.148-8T(d)(3) are also excluded from the definitions of "original proceeds" and "investment proceeds" set forth in sections 1.103-13(b)(2)(i) and 1.103-13(b)(2)(ii), respectively.

(b) EFFECTIVE DATE. This provision applies to private activity bonds issued after December 31, 1985, and to bonds other than private activity bonds issued after August 31, 1986.

* * * * *

There is a need for immediate guidance with respect to the provisions contained in this Treasury decision. For this reason, it is found impracticable to issue this Treasury decision with notice and public procedure under subsection (b) of section 553 of Title 5 of the United States Code or subject to the effective date limitation of subsection (d) of that section.