26 U.S.C. § 148 — Arbitrage

submitted 40 years ago by Pub. L. 99-514 to r/title-26-INTERNAL-REVENUE-CODE · 5,769 words · no verdicts yet

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This law stops governments from using tax-exempt bonds to earn extra investment profit, called arbitrage. A bond becomes taxable if too much of it is invested in higher-yielding investments outside narrow exceptions, like short temporary periods or reserve funds. Issuers must usually rebate the extra earnings to the United States, though construction projects and small issuers can use special rules or pay a penalty instead.

(a) Arbitrage bond defined. For section 103 purposes, a bond is an "arbitrage bond" if, when it's issued, any of its proceeds are reasonably expected to be used — directly or indirectly — to buy "higher yielding investments," or to replace money that was used to buy higher yielding investments. A bond is also treated as an arbitrage bond if the issuer later intentionally uses proceeds that way, even without that original expectation. (b) Higher yielding investments. "Higher yielding investments" means investment property whose yield over the bond's term is materially higher than the bond issue's own yield. "Investment property" includes securities (as defined by cross-reference to section 165(g)(2)(A) or (B)), obligations, annuity contracts, other investment-type property, and — for bonds other than private activity bonds — certain residential rental property that sits outside the issuer's jurisdiction and wasn't bought to carry out a court-ordered desegregation plan. Tax-exempt bonds generally are not "investment property," except that a "specified private activity bond" (as defined in section 57(a)(5)(C)) subject to the alternative minimum tax does count as investment property, unless it's part of an issue that includes such a bond. There's a safe harbor for prepaid natural gas: a prepayment under a "qualified natural gas supply contract" isn't investment-type property. Such a contract lets a government-owned utility prepay for natural gas for resale, as long as the yearly amount doesn't exceed the utility's recent average customer usage (plus gas needed to transport the prepaid gas to the utility). The subsection walks through detailed adjustments to that average: gas used to generate electricity counts only if the electricity is government-utility-generated and sold to the utility's own customers; the average can be adjusted up for new business customers and down for lost customers; the Secretary can raise the average on a ruling request showing real growth; the allowed amount is reduced by gas the utility already has on hand or has a right to acquire; the safe harbor stops applying if the utility deliberately inflates the volume bought; and the subsection defines "testing period" (the most recent five calendar years before issuance) and "service area." (c) Temporary period exception. A bond isn't an arbitrage bond merely because issue proceeds sit in higher yielding investments for a reasonable temporary period until they're needed for their intended purpose. For proceeds used to fund loans to two or more people, that temporary period is capped at six months; for proceeds from selling or repaying a loan that are used to fund more loans, the cap drops to three months; and for proceeds funding construction loans, related rules extend the period to two years. This exception doesn't apply to qualified mortgage bonds or qualified veterans' mortgage bonds. (d) Special rules for reasonably required reserve or replacement fund. A bond isn't an arbitrage bond merely because some proceeds sit in higher yielding investments as part of a reasonably required reserve or replacement fund, as long as that amount doesn't exceed 10 percent of the issue's proceeds (unless the issuer shows the Secretary a higher amount is necessary). If the fund actually exceeds that 10 percent limit (or an approved higher amount), the bond is treated as an arbitrage bond. (e) Minor portion may be invested in higher yielding investments. Beyond what subsections (c) and (d) already allow, a bond isn't an arbitrage bond just because a small additional amount is invested in higher yielding investments, as long as that amount doesn't exceed the lesser of 5 percent of the issue's proceeds or $100,000. (f) Required rebate to the United States. This is the core enforcement rule, and it has many parts. A bond is treated as an arbitrage bond if its issue doesn't meet the rebate and payment-timing requirements described here (this rule doesn't apply to qualified veterans' mortgage bonds). The rebate amount equals the excess of what was actually earned on "nonpurpose investments" over what would have been earned investing at the bond issue's own yield, plus any income earned on that excess; this total must be paid to the United States. Payments are made in installments at least once every five years, each large enough to bring total payments to 90 percent of what's owed at that point; the final installment is due within 60 days after the last bond in the issue is redeemed and must cover the remaining balance. A series of issues redeemed within a six-month period (or longer, if the Secretary allows) can be treated as one issue for this purpose if no bond in the series matures more than 270 days out or is a private activity bond. Tax and revenue anticipation bonds get a final-installment deadline of eight months after issuance. In calculating earnings on nonpurpose investments, gains and losses on selling those investments count, and earnings on a bona fide debt service fund are ignored if they're under $100,000 for the bond year (that dollar cap doesn't apply to non-private-activity issues with at least a five-year average maturity and interest rates that don't vary). There are temporary-investment safe harbors: an issue is treated as meeting the rebate rule if its gross proceeds are spent for the governmental purpose within six months of issuance (not counting money in a bona fide debt service fund or reasonably required reserve fund, or proceeds that arise later and weren't expected), with the rebate rule still applying to money not spent that fast. Issues that aren't private activity bonds (other than 501(c)(3) bonds) or tax/revenue anticipation bonds get a full year instead of six months for up to 5 percent of unspent proceeds. For tax and revenue anticipation bonds specifically, proceeds are treated as spent once the "cumulative cash flow deficit" they finance exceeds 90 percent of the issue's proceeds — the subsection defines that deficit and the measurement period (issuance date through the earlier of six months later or the computation date). Paying down bond principal doesn't count as "spending" proceeds for any of these tests. There's a separate exception from rebate for available construction proceeds of a "construction issue," if spending hits at least 10 percent within 6 months of issuance, 45 percent within 1 year, 75 percent within 18 months, and 100 percent within 2 years (a reasonable retainage of up to 5 percent is still fine if it's spent within 3 years). A "construction issue" is one where at least 75 percent of available construction proceeds fund construction on property owned by a government or 501(c)(3) organization, and every bond in the issue is a qualified 501(c)(3) bond, a non-private-activity bond, or a private activity bond financing government- or 501(c)(3)-owned property; "construction" includes reconstruction and rehabilitation. An issuer can elect to treat just the construction-funded portion of a larger issue as its own separate construction issue. "Available construction proceeds" means the issue price plus investment earnings (including reserve-fund earnings, with limits on how long those count), minus reserve-fund amounts and financed issuance costs, and excluding payments on purpose-related obligations; an issuer can also elect to exclude reserve-fund earnings entirely. Instead of rebating, an issuer can elect to pay a penalty of 1.5 percent, for each six-month period, of construction proceeds not yet spent as required — this penalty keeps applying until the issuer elects to end it (through a 3 percent one-time penalty plus yield restriction and using leftover proceeds to redeem bonds at the earliest call date, or an early-termination election once construction is substantially complete) or until the bonds fully mature. A late penalty payment that isn't due to willful neglect can still be treated as timely if the issuer pays an extra 50 percent of the shortfall plus interest; otherwise the affected bonds are treated as never having been tax-exempt. Issuers financing pooled loans can elect to start these construction-spending clocks separately for each loan, based on when it's made. These construction-issue rules generally don't apply to refunding bonds, with narrow exceptions. Separately, a small-issuer exception treats an issue as meeting the rebate and payment rules if it's issued by a government with general taxing power, no bond in it is a private activity bond, at least 95 percent of net proceeds fund local government activities, and the issuer doesn't expect to issue more than $5,000,000 of tax-exempt bonds (other than private activity bonds) that calendar year. Related issuing entities are combined as one issuer for this $5,000,000 test; certain refunding bonds are excluded from the count; a subordinate entity of a government with taxing power can get an allocated share of the $5,000,000 cap; refunding bonds keep the small-issuer exception only if the new issue is $5,000,000 or less, the refunded bonds also qualified for the exception, and the refunding bonds don't mature later than the bonds they refund (unless the original issue's average maturity was three years or less); there's a parallel transition rule for bonds issued before the Tax Reform Act of 1986; and the $5,000,000 cap can rise by up to an extra $10,000,000 for bonds financing public school construction. Money rebated to the United States isn't included in gross income, and no tax deduction is allowed for a rebate payment. "Nonpurpose investment" means investment property bought with gross proceeds that isn't used to carry out the issue's governmental purpose; "gross proceeds" includes amounts earned by investing the original proceeds (including principal repayments) and amounts set aside to pay debt service. Finally, if an issue would otherwise fail these rebate and payment rules, the Secretary can still treat it as compliant if no bond in it is a private activity bond (other than a 501(c)(3) bond), the failure wasn't due to willful neglect, and the issuer pays a penalty equal to 50 percent of the shortfall plus interest at the underpayment rate under section 6621 — the Secretary may waive all or part of that penalty. (g) Student loan incentive payments. Unless regulations say otherwise, special payments the Secretary of Education makes under section 438 of the Higher Education Act of 1965 aren't counted when figuring the yield on student loan notes for purposes of subsection (a)(1). (h) Determinations of yield. The yield on an issue is determined using the issue price, as defined in sections 1273 and 1274. (i) Regulations. The Secretary must issue whatever regulations are necessary or appropriate to carry out this section.

the actual law source: uscode.house.gov ↗public domain

(a) Arbitrage bond defined

For purposes of section 103, the term “arbitrage bond” means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly—

(1)

to acquire higher yielding investments, or

(2)

to replace funds which were used directly or indirectly to acquire higher yielding investments.

For purposes of this subsection, a bond shall be treated as an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described in paragraph (1) or (2).

(b) Higher yielding investments

For purposes of this section—

(1) In general

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

(2) Investment property

The term “investment property” means—

(A)

any security (within the meaning of section 165(g)(2)(A) or (B)),

(B)

any obligation,

(C)

any annuity contract,

(D)

any investment-type property, or

(E)

in the case of a bond other than a private activity bond, any residential rental property for family units which is not located within the jurisdiction of the issuer and which is not acquired to implement a court ordered or approved housing desegregation plan.

(3) Alternative minimum tax bonds treated as investment property in certain cases

(A) In general

Except as provided in subparagraph (B), the term “investment property” does not include any tax-exempt bond.

(B) Exception

With respect to an issue other than an issue a part of which is a specified private activity bond (as defined in section 57(a)(5)(C)), the term “investment property” includes a specified private activity bond (as so defined).

(4) Safe harbor for prepaid natural gas

(A) In general

The term “investment-type property” does not include a prepayment under a qualified natural gas supply contract.

(B) Qualified natural gas supply contract

For purposes of this paragraph, the term “qualified natural gas supply contract” means any contract to acquire natural gas for resale by a utility owned by a governmental unit if the amount of gas permitted to be acquired under the contract by the utility during any year does not exceed the sum of—

(i)

the annual average amount during the testing period of natural gas purchased (other than for resale) by customers of such utility who are located within the service area of such utility, and

(ii)

the amount of natural gas to be used to transport the prepaid natural gas to the utility during such year.

Natural gas used to generate electricity shall be taken into account in determining the average under subparagraph (B)(i)—

(i)

only if the electricity is generated by a utility owned by a governmental unit, and

(ii)

only to the extent that the electricity is sold (other than for resale) to customers of such utility who are located within the service area of such utility.

(D) Adjustments for changes in customer base

(i) New business customers

If—

(I)

after the close of the testing period and before the date of issuance of the issue, the utility owned by a governmental unit enters into a contract to supply natural gas (other than for resale) for a business use at a property within the service area of such utility, and

(II)

the utility did not supply natural gas to such property during the testing period or the ratable amount of natural gas to be supplied under the contract is significantly greater than the ratable amount of gas supplied to such property during the testing period,

then a contract shall not fail to be treated as a qualified natural gas supply contract by reason of supplying the additional natural gas under the contract referred to in subclause (I).

(ii) Lost customers

The average under subparagraph (B)(i) shall not exceed the annual amount of natural gas reasonably expected to be purchased (other than for resale) by persons who are located within the service area of such utility and who, as of the date of issuance of the issue, are customers of such utility.

(E) Ruling requests

The Secretary may increase the average under subparagraph (B)(i) for any period if the utility owned by the governmental unit establishes to the satisfaction of the Secretary that, based on objective evidence of growth in natural gas consumption or population, such average would otherwise be insufficient for such period.

(F) Adjustment for natural gas otherwise on hand

(i) In general

The amount otherwise permitted to be acquired under the contract for any period shall be reduced by—

(I)

the applicable share of natural gas held by the utility on the date of issuance of the issue, and

(II)

the natural gas (not taken into account under subclause (I)) which the utility has a right to acquire during such period (determined as of the date of issuance of the issue).

(ii) Applicable share

For purposes of the clause (i), the term “applicable share” means, with respect to any period, the natural gas allocable to such period if the gas were allocated ratably over the period to which the prepayment relates.

(G) Intentional acts

Subparagraph (A) shall cease to apply to any issue if the utility owned by the governmental unit engages in any intentional act to render the volume of natural gas acquired by such prepayment to be in excess of the sum of—

(i)

the amount of natural gas needed (other than for resale) by customers of such utility who are located within the service area of such utility, and

(ii)

the amount of natural gas used to transport such natural gas to the utility.

(H) Testing period

For purposes of this paragraph, the term “testing period” means, with respect to an issue, the most recent 5 calendar years ending before the date of issuance of the issue.

(I) Service area

For purposes of this paragraph, the service area of a utility owned by a governmental unit shall be comprised of—

(i)

any area throughout which such utility provided at all times during the testing period—

(I)

in the case of a natural gas utility, natural gas transmission or distribution services, and

(II)

in the case of an electric utility, electricity distribution services,

(ii)

any area within a county contiguous to the area described in clause (i) in which retail customers of such utility are located if such area is not also served by another utility providing natural gas or electricity services, as the case may be, and

(iii)

any area recognized as the service area of such utility under State or Federal law.

(1) In general

For purposes of subsection (a), a bond shall not be treated as an arbitrage bond solely by reason of the fact that the proceeds of the issue of which such bond is a part may be invested in higher yielding investments for a reasonable temporary period until such proceeds are needed for the purpose for which such issue was issued.

(2) Limitation on temporary period for pooled financings

(A) In general

The temporary period referred to in paragraph (1) shall not exceed 6 months with respect to the proceeds of an issue which are to be used to make or finance loans (other than nonpurpose investments) to 2 or more persons.

(B) Shorter temporary period for loan repayments, etc.

Subparagraph (A) shall be applied by substituting “3 months” for “6 months” with respect to the proceeds from the sale or repayment of any loan which are to be used to make or finance any loan. For purposes of the preceding sentence, a nonpurpose investment shall not be treated as a loan.

In the case of an issue described in subparagraph (A) any portion of which is used to make or finance loans for construction expenditures (within the meaning of subsection (f)(4)(C)(iv))—

(i)

rules similar to the rules of subsection (f)(4)(C)(v) shall apply, and

(ii)

subparagraph (A) shall be applied with respect to such portion by substituting “2 years” for “6 months”.

(D) Exception for mortgage revenue bonds

This paragraph shall not apply to any qualified mortgage bond or qualified veterans’ mortgage bond.

(d) Special rules for reasonably required reserve or replacement fund

(1) In general

For purposes of subsection (a), a bond shall not be treated as an arbitrage bond solely by reason of the fact that an amount of the proceeds of the issue of which such bond is a part may be invested in higher yielding investments which are part of a reasonably required reserve or replacement fund. The amount referred to in the preceding sentence shall not exceed 10 percent of the proceeds of such issue unless the issuer establishes to the satisfaction of the Secretary that a higher amount is necessary.

(2) Limitation on amount in reserve or replacement fund which may be financed by issue

A bond issued as part of an issue shall be treated as an arbitrage bond if the amount of the proceeds from the sale of such issue which is part of any reserve or replacement fund exceeds 10 percent of the proceeds of the issue (or such higher amount which the issuer establishes is necessary to the satisfaction of the Secretary).

(e) Minor portion may be invested in higher yielding investments

Notwithstanding subsections (a), (c), and (d), a bond issued as part of an issue shall not be treated as an arbitrage bond solely by reason of the fact that an amount of the proceeds of such issue (in addition to the amounts under subsections (c) and (d)) is invested in higher yielding investments if such amount does not exceed the lesser of—

(1)

5 percent of the proceeds of the issue, or

(2)

$100,000.

(f) Required rebate to the United States

(1) In general

A bond which is part of an issue shall be treated as an arbitrage bond if the requirements of paragraphs (2) and (3) are not met with respect to such issue. The preceding sentence shall not apply to any qualified veterans’ mortgage bond.

(2) Rebate to United States

An issue shall be treated as meeting the requirements of this paragraph only if an amount equal to the sum of—

(A)

the excess of—

(i)

the amount earned on all nonpurpose investments (other than investments attributable to an excess described in this subparagraph), over

(ii)

the amount which would have been earned if such nonpurpose investments were invested at a rate equal to the yield on the issue, plus

(B)

any income attributable to the excess described in subparagraph (A),

is paid to the United States by the issuer in accordance with the requirements of paragraph (3).

(3) Due date of payments under paragraph (2)

Except to the extent provided by the Secretary, the amount which is required to be paid to the United States by the issuer shall be paid in installments which are made at least once every 5 years. Each installment shall be in an amount which ensures that 90 percent of the amount described in paragraph (2) with respect to the issue at the time payment of such installment is required will have been paid to the United States. The last installment shall be made no later than 60 days after the day on which the last bond of the issue is redeemed and shall be in an amount sufficient to pay the remaining balance of the amount described in paragraph (2) with respect to such issue. A series of issues which are redeemed during a 6-month period (or such longer period as the Secretary may prescribe) shall be treated (at the election of the issuer) as 1 issue for purposes of the preceding sentence if no bond which is part of any issue in such series has a maturity of more than 270 days or is a private activity bond. In the case of a tax and revenue anticipation bond, the last installment shall not be required to be made before the date 8 months after the date of issuance of the issue of which the bond is a part.

(4) Special rules for applying paragraph (2)

(A) In general

In determining the aggregate amount earned on nonpurpose investments for purposes of paragraph (2)—

(i)

any gain or loss on the disposition of a nonpurpose investment shall be taken into account, and

(ii)

any amount earned on a bona fide debt service fund shall not be taken into account if the gross earnings on such fund for the bond year is less than $100,000.

In the case of an issue no bond of which is a private activity bond, clause (ii) shall be applied without regard to the dollar limitation therein if the average maturity of the issue (determined in accordance with section 147(b)(2)(A)) is at least 5 years and the rates of interest on bonds which are part of the issue do not vary during the term of the issue.

(B) Temporary investments

Under regulations prescribed by the Secretary—

(i) In general

An issue shall, for purposes of this subsection, be treated as meeting the requirements of paragraph (2) if—

(I)

the gross proceeds of such issue are expended for the governmental purposes for which the issue was issued no later than the day which is 6 months after the date of issuance of the issue, and

(II)

the requirements of paragraph (2) are met with respect to amounts not required to be spent as provided in subclause (I) (other than earnings on amounts in any bona fide debt service fund).

Gross proceeds which are held in a bona fide debt service fund or a reasonably required reserve or replacement fund, and gross proceeds which arise after such 6 months and which were not reasonably anticipated as of the date of issuance, shall not be considered gross proceeds for purposes of subclause (I) only.

(ii) Additional period for certain bonds

(I) In general

In the case of an issue described in subclause (II), clause (i) shall be applied by substituting “1 year” for “6 months” each place it appears with respect to the portion of the proceeds of the issue which are not expended in accordance with clause (i) if such portion does not exceed 5 percent of the proceeds of the issue.

(II) Issues to which subclause (I) applies

An issue is described in this subclause if no bond which is part of such issue is a private activity bond (other than a qualified 501(c)(3) bond) or a tax or revenue anticipation bond.

(iii) Safe harbor for determining when proceeds of tax and revenue anticipation bonds are expended

(I) In general

For purposes of clause (i), in the case of an issue of tax or revenue anticipation bonds, the net proceeds of such issue (including earnings thereon) shall be treated as expended for the governmental purpose of the issue on the 1st day after the date of issuance that the cumulative cash flow deficit to be financed by such issue exceeds 90 percent of the proceeds of such issue.

(II) Cumulative cash flow deficit

For purposes of subclause (I), the term “cumulative cash flow deficit” means, as of the date of computation, the excess of the expenses paid during the period described in subclause (III) which would ordinarily be paid out of or financed by anticipated tax or other revenues over the aggregate amount available (other than from the proceeds of the issue) during such period for the payment of such expenses.

(III) Period involved

For purposes of subclause (II), the period described in this subclause is the period beginning on the date of issuance of the issue and ending on the earlier of the date 6 months after such date of issuance or the date of the computation of cumulative cash flow deficit.

(iv) Payments of principal not to affect requirements

For purposes of this subparagraph, payments of principal on the bonds which are part of an issue shall not be treated as expended for the governmental purposes of the issue.

(i) In general

In the case of a construction issue, paragraph (2) shall not apply to the available construction proceeds of such issue if the spending requirements of clause (ii) are met.

(ii) Spending requirements

The spending requirements of this clause are met if at least—

(I)

10 percent of the available construction proceeds of the construction issue are spent for the governmental purposes of the issue within the 6-month period beginning on the date the bonds are issued,

(II)

45 percent of such proceeds are spent for such purposes within the 1-year period beginning on such date,

(III)

75 percent of such proceeds are spent for such purposes within the 18-month period beginning on such date, and

(IV)

100 percent of such proceeds are spent for such purposes within the 2-year period beginning on such date.

(iii) Exception for reasonable retainage

The spending requirement of clause (ii)(IV) shall be treated as met if—

(I)

such requirement would be met at the close of such 2-year period but for a reasonable retainage (not exceeding 5 percent of the available construction proceeds of the construction issue), and

(II)

100 percent of the available construction proceeds of the construction issue are spent for the governmental purposes of the issue within the 3-year period beginning on the date the bonds are issued.

(iv) Construction issue

For purposes of this subparagraph, the term “construction issue” means any issue if—

(I)

at least 75 percent of the available construction proceeds of such issue are to be used for construction expenditures with respect to property which is to be owned by a governmental unit or a 501(c)(3) organization, and

(II)

all of the bonds which are part of such issue are qualified 501(c)(3) bonds, bonds which are not private activity bonds, or private activity bonds issued to finance property to be owned by a governmental unit or a 501(c)(3) organization.

For purposes of this subparagraph, the term “construction” includes reconstruction and rehabilitation, and rules similar to the rules of section 142(b)(1)(B) shall apply.

(v) Portions of issues used for construction

If—

(I)

all of the construction expenditures to be financed by an issue are to be financed from a portion thereof, and

(II)

the issuer elects to treat such portion as a construction issue for purposes of this subparagraph,

then, for purposes of this subparagraph and subparagraph (B), such portion shall be treated as a separate issue.

(vi) Available construction proceeds

For purposes of this subparagraph—

(I) In general

The term “available construction proceeds” means the amount equal to the issue price (within the meaning of sections 1273 and 1274) of the construction issue, increased by earnings on the issue price, earnings on amounts in any reasonably required reserve or replacement fund not funded from the issue, and earnings on all of the foregoing earnings, and reduced by the amount of the issue price in any reasonably required reserve or replacement fund and the issuance costs financed by the issue.

(II) Earnings on reserve included only for certain periods

The term “available construction proceeds” shall not include amounts earned on any reasonably required reserve or replacement fund after the earlier of the close of the 2-year period described in clause (ii) or the date the construction is substantially completed.

(III) Payments on acquired purpose obligations excluded

The term “available construction proceeds” shall not include payments on any obligation acquired to carry out the governmental purposes of the issue and shall not include earnings on such payments.

(IV) Election to rebate on earnings on reserve

At the election of the issuer, the term “available construction proceeds” shall not include earnings on any reasonably required reserve or replacement fund.

(vii) Election to pay penalty in lieu of rebate

(I) In general

At the election of the issuer, paragraph (2) shall not apply to available construction proceeds which do not meet the spending requirements of clause (ii) if the issuer pays a penalty, with respect to each 6-month period after the date the bonds were issued, equal to 1½ percent of the amount of the available construction proceeds of the issue which, as of the close of such 6-month period, is not spent as required by clause (ii).

(II) Termination

The penalty imposed by this clause shall cease to apply only as provided in clause (viii) or after the latest maturity date of any bond in the issue (including any refunding bond with respect thereto).

(viii) Election to terminate 1½ percent penalty

At the election of the issuer (made not later than 90 days after the earlier of the end of the initial temporary period or the date the construction is substantially completed), the penalty under clause (vii) shall not apply to any 6-month period after the initial temporary period under subsection (c) if the requirements of subclauses (I), (II), and (III) are met.

(I) 3 percent penalty

The requirement of this subclause is met if the issuer pays a penalty equal to 3 percent of the amount of available construction proceeds of the issue which is not spent for the governmental purposes of the issue as of the close of such initial temporary period multiplied by the number of years (including fractions thereof) in the initial temporary period.

(II) Yield restriction at close of temporary period

The requirement of this subclause is met if the amount of the available construction proceeds of the issue which is not spent for the governmental purposes of the issue as of the close of such initial temporary period is invested at a yield not exceeding the yield on the issue or which is invested in any tax-exempt bond which is not investment property.

(III) Redemption of bonds at earliest call date

The requirement of this subclause is met if the amount of the available construction proceeds of the issue which is not spent for the governmental purposes of the issue as of the earliest date on which bonds may be redeemed is used to redeem bonds on such date.

(ix) Election to terminate 1½ percent penalty before end of temporary period

If—

(I)

the construction to be financed by a construction issue is substantially completed before the end of the initial temporary period,

(II)

the issuer identifies an amount of available construction proceeds which will not be spent for the governmental purposes of the issue,

(III)

the issuer has made the election under clause (viii), and

(IV)

the issuer makes an election under this clause before the close of the initial temporary period and not later than 90 days after the date the construction is substantially completed,

then clauses (vii) and (viii) shall be applied to the available construction proceeds so identified as if the initial temporary period ended as of the date the election is made.

(x) Failure to pay penalties

In the case of a failure (which is not due to willful neglect) to pay any penalty required to be paid under clause (vii) or (viii) in the amount or at the time prescribed therefor, the Secretary may treat such failure as not occurring if, in addition to paying such penalty, the issuer pays a penalty equal to the sum of—

(I)

50 percent of the amount which was not paid in accordance with clauses (vii) and (viii), plus

(II)

interest (at the underpayment rate established under section 6621) on the portion of the amount which was not paid on the date required for the period beginning on such date.

The Secretary may waive all or any portion of the penalty under this clause. Bonds which are part of an issue with respect to which there is a failure to pay the amount required under this clause (and any refunding bond with respect thereto) shall be treated as not being, and as never having been, tax-exempt bonds.

(xi) Election for pooled financing bonds

At the election of the issuer of an issue the proceeds of which are to be used to make or finance loans (other than nonpurpose investments) to 2 or more persons, the periods described in clauses (ii) and (iii) shall begin on—

(I)

the date the loan is made, in the case of loans made within the 1-year period after the date the bonds are issued, and

(II)

the date following such 1-year period, in the case of loans made after such 1-year period.

If such an election applies to an issue, the requirements of paragraph (2) shall apply to amounts earned before the beginning of the periods determined under the preceding sentence.

(xii) Payments of principal not to affect requirements

For purposes of this subparagraph, payments of principal on the bonds which are part of the construction issue shall not be treated as an expenditure of the available construction proceeds of the issue.

(xiii) Refunding bonds

(I) In general

Except as provided in this clause, clause (vii)(II), and the last sentence of clause (x), this subparagraph shall not apply to any refunding bond and no proceeds of a refunded bond shall be treated for purposes of this subparagraph as proceeds of a refunding bond.

(II) Determination of construction portion of issue

For purposes of clause (v), any portion of an issue which is used to refund any issue (or portion thereof) shall be treated as a separate issue.

(III) Coordination with rebate requirement on refunding bonds

The requirements of paragraph (2) shall be treated as met with respect to earnings for any period if a penalty is paid under clause (vii) or (viii) with respect to such earnings for such period.

(xiv) Elections

Any election under this subparagraph (other than clauses (viii) and (ix)) shall be made on or before the date the bonds are issued; and, once made, shall be irrevocable.

(xv) Time for payment of penalties

Any penalty under this subparagraph shall be paid to the United States not later than 90 days after the period to which the penalty relates.

(xvi) Treatment of bona fide debt service funds

If the spending requirements of clause (ii) are met with respect to the available construction proceeds of a construction issue, then paragraph (2) shall not apply to earnings on a bona fide debt service fund for such issue.

(D) Exception for governmental units issuing $5,000,000 or less of bonds

(i) In general

An issue shall, for purposes of this subsection, be treated as meeting the requirements of paragraphs (2) and (3) if—

(I)

the issue is issued by a governmental unit with general taxing powers,

(II)

no bond which is part of such issue is a private activity bond,

(III)

95 percent or more of the net proceeds of such issue are to be used for local governmental activities of the issuer (or of a governmental unit the jurisdiction of which is entirely within the jurisdiction of the issuer), and

(IV)

the aggregate face amount of all tax-exempt bonds (other than private activity bonds) issued by such unit during the calendar year in which such issue is issued is not reasonably expected to exceed $5,000,000.

(ii) Aggregation of issuers

For purposes of subclause (IV) of clause (i)—

(I)

an issuer and all entities which issue bonds on behalf of such issuer shall be treated as 1 issuer,

(II)

all bonds issued by a subordinate entity shall, for purposes of applying such subclause to each other entity to which such entity is subordinate, be treated as issued by such other entity, and

(III)

an entity formed (or, to the extent provided by the Secretary, availed of) to avoid the purposes of such subclause (IV) and all other entities benefiting thereby shall be treated as 1 issuer.

(iii) Certain refunding bonds not taken into account in determining small issuer status

There shall not be taken into account under subclause (IV) of clause (i) any bond issued to refund (other than to advance refund) any bond to the extent the amount of the refunding bond does not exceed the outstanding amount of the refunded bond.

(iv) Certain issues issued by subordinate governmental units, etc., exempt from rebate requirement

An issue issued by a subordinate entity of a governmental unit with general taxing powers shall be treated as described in clause (i)(I) if the aggregate face amount of such issue does not exceed the lesser of—

(I)

$5,000,000, or

(II)

the amount which, when added to the aggregate face amount of other issues issued by such entity, does not exceed the portion of the $5,000,000 limitation under clause (i)(IV) which such governmental unit allocates to such entity.

For purposes of the preceding sentence, an entity which issues bonds on behalf of a governmental unit with general taxing powers shall be treated as a subordinate entity of such unit. An allocation shall be taken into account under subclause (II) only if it is irrevocable and made before the issuance date of such issue and only to the extent that the limitation so allocated bears a reasonable relationship to the benefits received by such governmental unit from issues issued by such entity.

(v) Determination of whether refunding bonds eligible for exception from rebate requirement

If any portion of an issue is issued to refund other bonds, such portion shall be treated as a separate issue which does not meet the requirements of paragraphs (2) and (3) by reason of this subparagraph unless—

(I)

the aggregate face amount of such issue does not exceed $5,000,000,

(II)

each refunded bond was issued as part of an issue which was treated as meeting the requirements of paragraphs (2) and (3) by reason of this subparagraph,

(III)

the average maturity date of the refunding bonds issued as part of such issue is not later than the average maturity date of the bonds to be refunded by such issue, and

(IV)

no refunding bond has a maturity date which is later than the date which is 30 years after the date the original bond was issued.

Subclause (III) shall not apply if the average maturity of the issue of which the original bond was a part (and of the issue of which the bonds to be refunded are a part) is 3 years or less. For purposes of this clause, average maturity shall be determined in accordance with section 147(b)(2)(A).

(vi) Refundings of bonds issued under law prior to Tax Reform Act of 1986

If section 141(a) did not apply to any refunded bond, the issue of which such refunded bond was a part shall be treated as meeting the requirements of subclause (II) of clause (v) if—

(I)

such issue was issued by a governmental unit with general taxing powers,

(II)

no bond issued as part of such issue was an industrial development bond (as defined in section 103(b)(2), but without regard to subparagraph (B) of section 103(b)(3)) or a private loan bond (as defined in section 103(o)(2)(A), but without regard to any exception from such definition other than section 103(o)(2)(C)), and

(III)

the aggregate face amount of all tax-exempt bonds (other than bonds described in subclause (II)) issued by such unit during the calendar year in which such issue was issued did not exceed $5,000,000.

References in subclause (II) to section 103 shall be to such section as in effect on the day before the date of the enactment of the Tax Reform Act of 1986. Rules similar to the rules of clauses (ii) and (iii) shall apply for purposes of subclause (III). For purposes of subclause (II) of clause (i), bonds described in subclause (II) of this clause to which section 141(a) does not apply shall not be treated as private activity bonds.

(vii) Increase in exception for bonds financing public school capital expenditures

Each of the $5,000,000 amounts in the preceding provisions of this subparagraph shall be increased by the lesser of $10,000,000 or so much of the aggregate face amount of the bonds as are attributable to financing the construction (within the meaning of subparagraph (C)(iv)) of public school facilities.

(5) Exemption from gross income of sum rebated

Gross income shall not include the sum described in paragraph (2). Notwithstanding any other provision of this title, no deduction shall be allowed for any amount paid to the United States under paragraph (2).

(6) Definitions

For purposes of this subsection and subsections (c) and (d)—

(A) Nonpurpose investment

The term “nonpurpose investment” means any investment property which—

(i)

is acquired with the gross proceeds of an issue, and

(ii)

is not acquired in order to carry out the governmental purpose of the issue.

(B) Gross proceeds

Except as otherwise provided by the Secretary, the gross proceeds of an issue include—

(i)

amounts received (including repayments of principal) as a result of investing the original proceeds of the issue, and

(ii)

amounts to be used to pay debt service on the issue.

(7) Penalty in lieu of loss of tax exemption

In the case of an issue which would (but for this paragraph) fail to meet the requirements of paragraph (2) or (3), the Secretary may treat such issue as not failing to meet such requirements if—

(A)

no bond which is part of such issue is a private activity bond (other than a qualified 501(c)(3) bond),

(B)

the failure to meet such requirements is not due to willful neglect, and

(C)

the issuer pays to the United States a penalty in an amount equal to the sum of—

(i)

50 percent of the amount which was not paid in accordance with paragraphs (2) and (3), plus

(ii)

interest (at the underpayment rate established under section 6621) on the portion of the amount which was not paid on the date required under paragraph (3) for the period beginning on such date.

The Secretary may waive all or any portion of the penalty under this paragraph.

(g) Student loan incentive payments

Except to the extent otherwise provided in regulations, payments made by the Secretary of Education pursuant to section 438 of the Higher Education Act of 1965 are not to be taken into account, for purposes of subsection (a)(1), in determining yields on student loan notes.

(h) Determinations of yield

For purposes of this section, the yield on an issue shall be determined on the basis of the issue price (within the meaning of sections 1273 and 1274).

(i) Regulations

The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.

Source credit: (Added Pub. L. 99–514, title XIII, § 1301(b), Oct. 22, 1986, 100 Stat. 2641; amended Pub. L. 100–647, title I, § 1013(a)(14)–(16)(A), (17)(A), (B), (18), (19), (43)(A), (B), title IV, § 4005(d)(2), title V, § 5053(b), title VI, §§ 6177(a), (b), 6181(a), (b), 6183(a), Nov. 10, 1988, 102 Stat. 3539, 3540, 3542, 3545, 3646, 3678, 3726, 3727, 3729; Pub. L. 101–239, title VII, §§ 7652(a)–(d), 7814(c)(2), 7816(r), (t), Dec. 19, 1989, 103 Stat. 2385–2387, 2413, 2423; Pub. L. 101–508, title XI, § 11701(j)(1)–(6), Nov. 5, 1990, 104 Stat. 1388–508 to 1388–513; Pub. L. 105–34, title II, § 223(a), title XIV, §§ 1441–1444, Aug. 5, 1997, 111 Stat. 818, 1053, 1054; Pub. L. 107–16, title IV, § 421(a), June 7, 2001, 115 Stat. 64; Pub. L. 109–58, title XIII, § 1327(a), Aug. 8, 2005, 119 Stat. 1017; Pub. L. 109–222, title V, § 508(c), May 17, 2006, 120 Stat. 362; Pub. L. 115–97, title I, § 13532(b)(2), Dec. 22, 2017, 131 Stat. 2154.)

history & why it existsrecord from the source credit

1986Enacted · Pub. L. 99-514 · 100 Stat. 2641
1988Amended · Pub. L. 100-647 · 102 Stat. 3539, 3540, 3542, 3545, 3646, 3678, 3726, 3727, 3729
1989Amended · Pub. L. 101-239 · 103 Stat. 2385
1990Amended · Pub. L. 101-508 · 104 Stat. 1388
1997Amended · Pub. L. 105-34 · 111 Stat. 818, 1053, 1054
2001Amended · Pub. L. 107-16 · 115 Stat. 64
2005Amended · Pub. L. 109-58 · 119 Stat. 1017
2006Amended · Pub. L. 109-222 · 120 Stat. 362
2017Amended · Pub. L. 115-97 · 131 Stat. 2154

A history note hasn’t been published yet. The record shows enactment by Pub. L. 99-514 on 1986-10-22.

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