§ 148. Arbitrage
(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—
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.
(3)
Alternative minimum tax bonds treated as investment property in certain cases
(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—
(C)
Natural gas used to generate electricity
Natural gas used to generate electricity shall be taken into account in determining the average under subparagraph (B)(i)—
(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
(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—
(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—
(c)
Temporary period exception
(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.
(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—
(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—
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)—
(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.
(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.
(C)
Exception from rebate for certain proceeds to be used to finance construction expenditures
(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)
Exception for reasonable retainage
The spending requirement of clause (ii)(IV) shall be treated as met if—
(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.
(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 11/2 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).
(viii)
Election to terminate 11/2 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 11/2 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,
(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—
(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
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.
(xiv)
Determination of initial temporary period
For purposes of this subpargraph,[1] the end of the initial temporary period shall be determined without regard to section
149
(d)(3)(A)(iv).
(xv)
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.
(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—
(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,
(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—
(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—
(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—
(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)—
(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),
(C)
the issuer pays to the United States a penalty in an amount equal to the sum of—
(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.
(i)
Regulations
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.
[1] So in original. Probably should be “subparagraph,”.