[Federal Register Volume 68, Number 238 (Thursday, December 11, 2003)]
[Rules and Regulations]
[Pages 69020-69024]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-30635]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9097]
RIN 1545-AX22
Arbitrage Restrictions Applicable to Tax-Exempt Bonds Issued by
State and Local Governments
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations on the arbitrage
restrictions applicable to tax-exempt bonds issued by state and local
governments. The regulations affect issuers of tax-exempt bonds and
provide a safe harbor for qualified administrative costs for broker's
commissions and similar fees incurred in connection with the
acquisition of guaranteed investment contracts or investments purchased
for a yield restricted defeasance escrow.
DATES: Effective Date: These regulations are effective February 9,
2004.
Applicability Date: For dates of applicability, see Sec. 1.148-
11(i) of these regulations.
FOR FURTHER INFORMATION CONTACT: Rose M. Weber, (202) 622-3980 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document amends 26 CFR part 1 under section 148 of the
Internal Revenue Code by providing rules for determining when certain
brokers' commissions or similar fees are qualified administrative costs
(the final regulations). On August 27, 1999, the IRS published in the
Federal Register a notice of proposed rulemaking (REG-105565-99)(64 FR
46876) (the proposed regulations). The proposed regulations modify
Sec. 1.148-5(e)(2) to provide a safe harbor for determining whether
brokers' commissions and similar fees incurred in connection with the
acquisition of guaranteed investment contracts or investments purchased
for a yield restricted defeasance escrow are treated as qualified
administrative costs. Comments on the proposed regulations were
received and a hearing was held on December 14, 1999. After
consideration of all the comments, the proposed regulations are adopted
as revised by this Treasury decision. The revisions are discussed
below.
Explanation of Provisions
I. Existing Regulations
A. Investment Yield and Administrative Costs
Section 148 limits the yield on investments purchased with proceeds
of tax-exempt bonds. In general, under Sec. 1.148-5(b)(1) of the
existing regulations, the yield on an investment is computed by
comparing receipts from the investment to payments for the investment.
Section 1.148-5(e)(1) provides that the yield on an investment
generally is not adjusted to take into account any costs or expenses
paid, directly or indirectly, to purchase, carry, sell, or retire the
investment (administrative costs). However, Sec. 1.148-5(e)(2)(i)
provides that the yield on nonpurpose investments (as defined in Sec.
1.148-1(b)) is adjusted to take into account qualified administrative
costs. Qualified administrative costs are reasonable, direct
administrative costs, other than carrying costs, such as separately
stated brokerage or selling commissions, but not legal and accounting
fees, recordkeeping, custody, and similar costs. In general, under
Sec. 1.148-5(e)(2)(i), administrative costs are not reasonable unless
they are comparable to administrative costs that would be charged for
the same investment or a reasonably comparable investment if acquired
with a source of funds other than gross proceeds of tax-exempt bonds
(the comparability standard).
B. Special Rule for Guaranteed Investment Contracts
Section 1.148-5(e)(2)(iii) of the existing regulations provides
that, for a guaranteed investment contract, a broker's commission or
similar fee paid on behalf of either an issuer or the guaranteed
investment contract provider generally is a qualified administrative
[[Page 69021]]
cost to the extent that the present value of the commission, as of the
date the contract is allocated to the issue, does not exceed the lesser
of (x) a reasonable amount within the meaning of Sec. 1.148-5(e)(2)(i)
or (y) the present value of annual payments equal to .05 percent of the
weighted average amount reasonably expected to be invested each year of
the term of the contract. Present value is computed using the taxable
discount rate used by the parties to compute the commission, or if not
readily ascertainable, the yield to the issuer on the investment
contract or other reasonable taxable discount rate.
C. Special Rule for Yield Restricted Defeasance Escrows
Section 1.148-5(e)(2)(iv) of the existing regulations provides
that, for investments purchased for a yield restricted defeasance
escrow, a fee paid to a bidding agent is a qualified administrative
cost only if the fee is comparable to a fee that would be charged for a
reasonably comparable investment if acquired with a source of funds
other than gross proceeds of tax-exempt bonds, and it is reasonable.
The fee is deemed to meet both the comparability and reasonableness
requirements if it does not exceed the lesser of $10,000 or .1 percent
of the initial principal amount of investments deposited in the yield
restricted defeasance escrow.
II. Proposed Regulations
The proposed regulations were issued in response to comments
stating that issuers were having difficulty applying Sec. 1.148-
5(e)(2)(iii) and (iv), primarily because of uncertainty about whether a
particular broker's commission or similar fee is reasonable. The
proposed regulations delete the existing provisions of Sec. 1.148-
5(e)(2)(iii) and (iv) and create a single rule for qualified
administrative costs that treats a broker's commission or similar fee
incurred in connection with a guaranteed investment contract or
investments purchased for a yield restricted defeasance escrow as a
qualified administrative cost if the fee is reasonable within the
meaning of Sec. 1.148-5(e)(2)(i) of the existing regulations.
The proposed regulations also set forth a safe harbor, which treats
a broker's commission or similar fee incurred in connection with the
acquisition of a guaranteed investment contract or investments
purchased for a yield restricted defeasance escrow as reasonable within
the meaning of Sec. 1.148-5(e)(2)(i) if two requirements are met.
Under the first requirement for the safe harbor, the amount of the
broker's commission or similar fee treated by the issuer as a qualified
administrative cost cannot exceed the lesser of $25,000 or 0.2 percent
of the computational base (the per-investment safe harbor). For
guaranteed investment contracts, the computational base is the
aggregate amount reasonably expected as of the issue date to be
deposited over the term of the contract. For example, for a guaranteed
investment contract used to earn a return on what otherwise would be
idle cash balances from maturing investments in a yield restricted
defeasance escrow, the aggregate amount reasonably expected to be
deposited includes all periodic deposits reasonably expected to be made
pursuant to the terms of the contract. For investments, other than
guaranteed investment contracts, deposited in a yield restricted
defeasance escrow, the computational base is the initial amount
invested in those investments. Under the second requirement for the
safe harbor, for any issue of bonds, the issuer cannot treat as
qualified administrative costs more than $75,000 in brokers'
commissions or similar fees with respect to all guaranteed investment
contracts and investments for yield restricted defeasance escrows
purchased with gross proceeds of the issue (the per-issue safe harbor).
III. Final Regulations
A. Safe Harbor Approach
Some commentators suggested that the existing regulations, coupled
with competitive market forces, work well to produce reasonable
brokers' fees. Commentators also suggested that the proposed
regulations will eliminate much of the incentive for the independent
bidding agent to actively participate in the market, with the result
that, in many cases, tax-exempt bond proceeds will be placed in lower-
yielding and often riskier investments. These commentators recommended
against adopting the safe harbor in the proposed regulations.
Other commentators suggested that the existing regulations do not
work well. They stated that the current rules provide little practical
guidance upon which an issuer can rely to determine whether a broker's
fee for a guaranteed investment contract is a reasonable amount. These
commentators recommended that the safe harbor be adopted with
modifications. They suggested that the safe harbor will provide a much
needed level of certainty.
The IRS and Treasury Department do not believe the final
regulations will result in tax-exempt bond proceeds being invested in
low-yielding, risky investments because the regulations do not
adversely affect an issuer's incentive to realize investment earnings
and to invest in secure investments. To provide simplicity and
certainty, the final regulations retain the safe harbor, with certain
modifications discussed below. The final regulations do not limit the
amount of brokers' fees that may be paid by issuers. Thus, for example,
the final regulations do not restrict the ability of an issuer to pay a
particular fee that exceeds the safe harbor amount. Furthermore,
brokers' commissions or similar fees in excess of the safe harbor are
qualified administrative costs if they are reasonable within the
meaning of Sec. 1.148-5(e)(2)(i).
B. Per-Investment Safe Harbor
Commentators suggested that, if the per-investment safe harbor is
retained, it should be increased. These commentators stated that in
some circumstances the safe harbor does not reflect the value provided
by brokers, particularly in the case of small or large transactions and
long-term debt service reserve fund investments. Suggestions for
modifying the per-investment safe harbor included adding a minimum fee
for smaller transactions and a sliding scale for larger transactions.
Commentators also suggested increasing the computational base for long-
term guaranteed investment contracts by treating them as a series of
shorter-term contracts.
The final regulations increase the $25,000 amount to $30,000 and
provide for a minimum fee of $3,000. Thus, if 0.2 percent of the
computational base is less than $3,000, the per-investment safe harbor
is $3,000. The final regulations do not adopt a sliding scale and do
not treat long-term contracts as a series of shorter-term contracts
because the IRS and Treasury Department have concluded that the per-
investment safe harbor in the final regulations provides much needed
certainty without requiring issuers to pay less than fair market value
for brokers' fees.
C. Per-Issue Safe Harbor
Commentators recommended that the per-issue safe harbor be
increased or eliminated. Some commentators suggested replacing the per-
issue safe harbor with an anti-abuse rule to prevent the artificial
creation of multiple investments when a single investment would be
appropriate. Suggestions included aggregating separate investments that
(1) are made at or about the same time if the bond proceeds being
invested have similar
[[Page 69022]]
rebate or yield characteristics, or (2) would normally be bid together
as a single investment unless there was a good business reason for the
separation.
The final regulations retain the per-issue safe harbor and increase
the $75,000 amount to $85,000. To maintain simplicity and certainty,
the final regulations do not adopt the suggestion to replace the per-
issue safe harbor with an anti-abuse rule. The IRS and Treasury
Department have concluded that the per-issue safe harbor in the final
regulations limits artificial separation of investments without
requiring issuers to pay less than fair market value for brokers' fees.
D. Fees in Excess of Safe Harbor
Some commentators requested guidance on the factors for determining
whether a fee in excess of the safe harbor is reasonable. Suggested
factors included the duration of the contract, the complexity of its
terms, the creditworthiness of the issuer, the availability of
providers to deliver the contract, the presence of unusual features in
the issue or the contract, custom in the industry, and the level of
risk to the broker. The IRS and Treasury Department have considered the
suggested factors and have concluded that they do not represent
administrable standards for determining whether a particular fee is
reasonable. Therefore, the final regulations do not specify factors for
determining the reasonableness of fees in excess of the safe harbor.
Under the final regulations, the determination of whether a fee is
reasonable is made based on all the facts and circumstances, including
whether the fee satisfies the comparability standard in Sec. 1.148-
5(e)(2)(i).
Some commentators suggested that the portion of a fee that is
within the safe harbor should be a qualified administrative cost, even
if the total fee exceeds the safe harbor. The final regulations adopt
this suggestion.
E. Computational Base for Guaranteed Investment Contracts
Commentators suggested that the computational base for a guaranteed
investment contract should be determined as of the date the contract is
acquired, rather than the issue date, so that the safe harbor may be
applied to guaranteed investment contracts that are not anticipated on
the issue date. The final regulations adopt this suggestion.
F. Cost-of-Living Adjustments
Commentators requested that the final regulations provide for
periodic adjustments to the dollar limits in the safe harbor to reflect
inflation. The final regulations provide a cost-of-living adjustment
for both the per-investment safe harbor and the per-issue safe harbor.
The adjusted safe harbor dollar amounts will be published in the annual
revenue procedure that sets forth inflation-adjusted items.
G. Interpretative Rule
One commentator questioned whether the proposed regulations should
have been classified as a legislative rule. The IRS and Treasury
Department have reviewed the applicable authorities and have determined
that the regulations are properly classified as an interpretative rule.
Effective Dates
The final regulations apply to bonds sold on or after February 9,
2004. In the case of bonds sold before February 9, 2004, that are
subject to Sec. 1.148-5 (pre-effective date bonds), issuers may apply
the final regulations, in whole but not in part, with respect to
transactions entered into on or after December 11, 2003. If an issuer
applies the final regulations to pre-effective date bonds, the per-
issue safe harbor is applied by taking into account all brokers'
commissions or similar fees with respect to guaranteed investment
contracts and investments for yield restricted defeasance escrows that
the issuer treats as qualified administrative costs for the issue,
including all such commissions or fees paid before February 9, 2004.
For purposes of Sec. Sec. 1.148-5(e)(2)(iii)(B)(3) and 1.148-
5(e)(2)(iii)(B)(6) of the final regulations (relating to cost-of-living
adjustments), transactions entered into before 2003 are treated as
entered into in 2003.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because the
rule does not impose a collection of information on small entities, the
provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply.
Drafting Information
The principal authors of these final regulations are Rose M. Weber
and Rebecca L. Harrigal, Office of Chief Counsel, IRS (TE/GE), and
Stephen J. Watson, Office of Tax Policy, Treasury Department. However,
other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
1. The authority citation for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
0
2. Section 1.148-0 is amended by revising the entry in paragraph (c)
for Sec. 1.148-11 (i) to read as follows:
Sec. 1.148-0 Scope and table of contents.
* * * * *
(c) Table of contents.
* * * * *
Sec. 1.148-11 Effective dates.
* * * * *
(i) Special rule for certain broker's commissions and similar
fees.
* * * * *
0
3. In Sec. 1.148-5, paragraph (e) is amended as follows:
0
1. Paragraph (e)(2)(iii) is revised.
0
2. Paragraph (e)(2)(iv) is removed.
The revision reads as follows:
Sec. 1.148-5 Yield and valuation of investments.
* * * * *
(e) * * *
(2) * * *
(iii) Special rule for guaranteed investment contracts and
investments purchased for a yield restricted defeasance escrow--(A) In
general. An amount paid for a broker's commission or similar fee with
respect to a guaranteed investment contract or investments purchased
for a yield restricted defeasance escrow is a qualified administrative
cost if the fee is reasonable within the meaning of paragraph (e)(2)(i)
of this section.
(B) Safe harbor--(1) In general. A broker's commission or similar
fee with respect to the acquisition of a guaranteed investment contract
or investments purchased for a yield restricted defeasance escrow is
reasonable within the meaning of paragraph (e)(2)(i) of this section to
the extent that--
(i) The amount of the fee that the issuer treats as a qualified
administrative cost does not exceed the lesser of:
(A) $30,000 and
(B) 0.2% of the computational base or, if more, $3,000; and
[[Page 69023]]
(ii) For any issue, the issuer does not treat as qualified
administrative costs more than $85,000 in brokers' commissions or
similar fees with respect to all guaranteed investment contracts and
investments for yield restricted defeasance escrows purchased with
gross proceeds of the issue.
(2) Computational base. For purposes of paragraph (e)(2)(iii)(B)(1)
of this section, computational base shall mean--
(i) For a guaranteed investment contract, the amount of gross
proceeds the issuer reasonably expects, as of the date the contract is
acquired, to be deposited in the guaranteed investment contract over
the term of the contract, and
(ii) For investments (other than guaranteed investment contracts)
to be deposited in a yield restricted defeasance escrow, the amount of
gross proceeds initially invested in those investments.
(3) Cost-of-living adjustment. In the case of a calendar year after
2004, each of the dollar amounts in paragraph (e)(2)(iii)(B)(1) of this
section shall be increased by an amount equal to--
(i) Such dollar amount; multiplied by
(ii) The cost-of-living adjustment determined under section 1(f)(3)
for such calendar year by using the language ``calendar year 2003''
instead of ``calendar year 1992'' in section 1(f)(3)(B).
(4) Rounding. If any increase determined under paragraph
(e)(2)(iii)(B)(3) of this section is not a multiple of $1,000, such
increase shall be rounded to the nearest multiple thereof.
(5) Applicable year for cost-of-living adjustment. The cost-of-
living adjustments under paragraph (e)(2)(iii)(B)(3) of this section
shall apply to the safe harbor amounts under paragraph
(e)(2)(iii)(B)(1) of this section based on the year the guaranteed
investment contract or the investments for the yield restricted
defeasance escrow, as applicable, are acquired.
(6) Cost-of-living adjustment to determine remaining amount of per-
issue safe harbor--(i) In general. This paragraph (e)(2)(iii)(B)(6)
applies to determine the portion of the safe harbor amount under
paragraph (e)(2)(iii)(B)(1)(ii) of this section, as modified by
paragraph (e)(2)(iii)(B)(3) of this section (the per-issue safe
harbor), that is available (the remaining amount) for any year (the
determination year) if the per-issue safe harbor was partially used in
one or more prior years.
(ii) Remaining amount of per-issue safe harbor. The remaining
amount of the per-issue safe harbor for any determination year is equal
to the per-issue safe harbor for that year, reduced by the portion of
the per-issue safe harbor used in one or more prior years.
(iii) Portion of per-issue safe harbor used in prior years. The
portion of the per-issue safe harbor used in any prior year (the prior
year) is equal to the total amount of broker's commissions or similar
fees paid in connection with guaranteed investment contracts or
investments for a yield restricted defeasance escrow acquired in the
prior year that the issuer treated as qualified administrative costs
for the issue, multiplied by a fraction the numerator of which is the
per-issue safe harbor for the determination year and the denominator of
which is the per-issue safe harbor for the prior year. See paragraph
(e)(2)(iii)(C) Example 2 of this section.
(C) Examples. The following examples illustrate the application of
the safe harbor in paragraph (e)(2)(iii)(B) of this section:
Example 1. Multipurpose issue. In 2003, the issuer of a
multipurpose issue uses brokers to acquire the following investments
with gross proceeds of the issue: a guaranteed investment contract
for amounts to be deposited in a construction fund (construction
GIC), Treasury securities to be deposited in a yield restricted
defeasance escrow (Treasury investments) and a guaranteed investment
contract that will be used to earn a return on what otherwise would
be idle cash balances from maturing investments in the yield
restricted defeasance escrow (the float GIC). The issuer deposits
$22,000,000 into the construction GIC and reasonably expects that no
further deposits will be made over its term. The issuer uses
$8,040,000 of the proceeds to purchase the Treasury investments. The
issuer reasonably expects that it will make aggregate deposits of
$600,000 to the float GIC over its term. The brokers' fees are
$30,000 for the construction GIC, $16,080 for the Treasury
investments and $3,000 for the float GIC. The issuer has not
previously treated any brokers' commissions or similar fees as
qualified administrative costs. The issuer may claim all $49,080 in
brokers' fees for these investments as qualified administrative
costs because the fees do not exceed the safe harbors in paragraph
(e)(2)(iii)(B) of this section. Specifically, each of the brokers'
fees equals the lesser of $30,000 and 0.2% of the computational base
(or, if more, $3,000) (i.e., lesser of $30,000 and 0.2% x
$22,000,000 for the construction GIC; lesser of $30,000 and 0.2% x
$8,040,000 for the Treasury investments; and lesser of $30,000 and
$3,000 for the float GIC). In addition, the total amount of brokers'
fees claimed by the issuer as qualified administrative costs
($49,080) does not exceed the per-issue safe harbor of $85,000.
Example 2. Cost-of-living adjustment. In 2003, an issuer issues
bonds and uses gross proceeds of the issue to acquire two guaranteed
investment contracts. The issuer pays a total of $50,000 in brokers'
fees for the two guaranteed investment contracts and treats these
fees as qualified administrative costs. In a year subsequent to 2003
(Year Y), the issuer uses gross proceeds of the issue to acquire two
additional guaranteed investment contracts, paying a total of
$20,000 in broker's fees for the two guaranteed investment
contracts, and treats those fees as qualified administrative costs.
For Year Y, applying the cost-of-living adjustment under paragraph
(e)(2)(iii)(B)(3) of this section, the safe harbor dollar limits
under paragraph (e)(2)(iii)(B)(1) of this section are $3,000,
$32,000 and $90,000. The remaining amount of the per-issue safe
harbor for Year Y is $37,059 ($90,000-[$50,000 x $90,000/$85,000]).
The broker's fees in Year Y do not exceed the per-issue safe harbor
under paragraph (e)(2)(iii)(B)(1)(ii) (as modified by paragraph
(e)(2)(iii)(B)(3)) of this section because the broker's fees do not
exceed the remaining amount of the per-issue safe harbor determined
under paragraph (e)(2)(iii)(B)(6) of this section for Year Y. In a
year subsequent to Year Y (Year Z), the issuer uses gross proceeds
of the issue to acquire an additional guaranteed investment
contract, pays a broker's fee of $15,000 for the guaranteed
investment contract, and treats the broker's fee as a qualified
administrative cost. For Year Z, applying the cost-of-living
adjustment under paragraph (e)(2)(iii)(B)(3) of this section, the
safe harbor dollar limits under paragraph (e)(2)(iii)(B)(1) of this
section are $3,000, $33,000 and $93,000. The remaining amount of the
per-issue safe harbor for Year Z is $17,627 ($93,000--[($50,000 x
$93,000/$85,000) + ($20,000 x $93,000/$90,000)]). The broker's fee
incurred in Year Z does not exceed the per-issue safe harbor under
paragraph (e)(2)(iii)(B)(1)(ii) (as modified by paragraph
(e)(2)(iii)(B)(3)) of this section because the broker's fee does not
exceed the remaining amount of the per-issue safe harbor determined
under paragraph (e)(2)(iii)(B)(6) of this section for Year Z. See
paragraph (e)(2)(iii)(B)(6) of this section.
* * * * *
0
4. Section 1.148-11 is amended by revising paragraph (i) to read as
follows:
Sec. 1.148-11 Effective dates.
* * * * *
(i) Special rule for certain broker's commissions and similar fees.
Section 1.148-5(e)(2)(iii) applies to bonds sold on or after February
9, 2004. In the case of bonds sold before February 9, 2004, that are
subject to Sec. 1.148-5 (pre-effective date bonds), issuers may apply
Sec. 1.148-5(e)(2)(iii), in whole but not in part, with respect to
transactions entered into on or after December 11, 2003. If an issuer
applies Sec. 1.148-5(e)(2)(iii) to pre-effective date bonds, the per-
issue safe harbor in Sec. 1.148-5(e)(2)(iii)(B)(1)(ii) is applied by
taking into account all brokers' commissions or similar fees with
respect to guaranteed investment contracts and investments for yield
restricted defeasance escrows
[[Page 69024]]
that the issuer treats as qualified administrative costs for the issue,
including all such commissions or fees paid before February 9, 2004.
For purposes of Sec. Sec. 1.148-5(e)(2)(iii)(B)(3) and 1.148-
5(e)(2)(iii)(B)(6) (relating to cost-of-living adjustments),
transactions entered into before 2003 are treated as entered into in
2003.
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Approved: December 2, 2003.
Gregory Jenner,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 03-30635 Filed 12-10-03; 8:45 am]
BILLING CODE 4830-01-P