HomeMy WebLinkAboutResolution 47-1997 •- � _i
RESOLUTION 47-97
DECLARING OFFICIAL INTENT TO REIlVIBURSE
WHEREAS, the City of Brookings, a municipal corporation, (hereinafter the"City") has
deternuned to proceed with a project (as described in Exhibit A hereto, the"Project"), and intends
to obtain financing with respect to the Project as least in part through the issuance of tax-exempt
debt;
WHEREAS, the City desires that all permitted Project costs paid prior to the issuance of
tax-exempt bonds qualify for reimbursement from the proceeds of issuance of such tax-exempt
bonds under the applicable Treasury regulations.
NOW, THEREFORE, BE IT RESOLVED AS FOLLOWS:
1. It is desirable that certain expenditures for or in relation to the Project be incurred and paid
prior to the issuance to taac-exempt bonds to finance such expenditures commencing on
June 1, 1997.
2. Such expenditures, not to exceed $650,000.00, are expected to be made in the foreseeable
future with respect to the Project, as further described in Exhibit A hereto;
3. The City reasonably expects to reimburse the above-described expenditures by incurring debt
in the form of t�-exempt bonds in an amount not exceeding $2,600,000 and reasonably
expects that actual project costs to be reimbursed from such bond proceeds will probably be
less, depending on the date on which such bonds are issued and the completion schedule for
the Project.
4. No funds(from sources other than such debt) are, or are reasonably expected to be, allocated
on a long-term basis, reserved or otherwise set aside pursuant to the corporation's budget or
financial policies for such expenditures at this time;
5. In connection with the Project, authority is hereby specifically confened on the designated
officer of the City to make such further declarations of official reimbursement intent on behalf
of this corporation it may be necessary or desirable and as may be consistent with then-
existing budgetary and financial circumstances of the City.
Passed and approved this 3rd day of June 1997.
� �
Mayor
,o�c�,"'on�r���
� .�
�� M"R.9 •o
3
� o<
o ,�Z.
S
Finance Officer
} � , � ,
EXIIIBIT A-1
The Brookings Public Library will be expanding its facility during 1997-1998, adding
16,000 square feet and remodeling 2,500 square feet. The expansion would encompass what is
currently the library paxking lot. The city-owned former VFW building and the municipal utilities
line shop would be removed and that area used for parking. Total cost of the project is
$2,600,000. Funding for the project was approved by public vote and Commission vote in
February 1997.
1. The proposed construction and acquisition of equipment or other qualifying property
for the Public Library Expansion project as defined by Resolution No. 47-97.
• � ' - �*���1�'t` S�PPc.iZi►rt�wi
GOVERNMENT DEBT FINANCING
The 1992 R,egulations also provide safe harbor rules for .
the determination of yield on certificates of deposit.3o
Expenditures
The allocation of gross proceeds to expenditures is, of
course, the most important event in arbitrage analysis,
because once amounts are spent (allocated to expenditures)
they are no longer subject to the arbitrage restrictions. The
R,egulations generally permit proceeds to be allocated to
expenditures in any reasonable, consistently applied man-
ner.31 R,easonable methods of allocating various sources of
funds to expenditures for the same governmental purpose
include "specific tracing," "gross proceeds spent first," "first in,
first out" or ratable allocation. The allocation must be to carry
out a governmental purpose and must involve a reasonably
current outlay of cash.32 The purchase of a nonpurpose invest-
� ment is not an expenditure. Nor is a transfer "to finance a
nondiscretionary legal funding obligation(but not a legal judg-
ment)for a governmental purpose"33 an expenditure, until the
recipient uses the transferred funds to carry out that govern-
mental purpose. Proceeds invested in a purpose investment
are spent when spent by the conduit borrower.34 The R,egula-
tions provide, however, that investment in qualified
mortgages or student loans is expenditures,35 though presum-
ably interest paid on such investments is investment proceeds,
so that, for at least some purposes, original proceeds are not
decreased when used to acquire such investments.
Reimbursement
Though not part of the 1992 Regulations, the Z`reasury,on
January 30, 1992, finalized its major rewrite of the reimburse-
ment R,egulations,36 which describe when bond proceeds may
ao�g§ 1.148-4(c)(5).
a�Reg§ 1.148-4(d)(1)(i)•
32 Reg§ 1.148-4(d)(1)(ii). See generally§ 7:07.
�Reg§ 1.148-4(d)(1)(ii).
�Reg§ 1.148-4(d)(2)(i). See generally§ 7:37.
�Reg§ 1.148-4(d)(2)(ii).
�57 Fed Reg 3,526,TD 8394(Jan. 30, 1992).
8
. �
• < <
1992 SPECIAL SUPPLEMENT TO CHAPTER 7
be used to reimburse an issuer for expenditures made prior to
the issuance of the bonds. (The Regulations speak in terms of
allocating bond proceeds to expenditures paid prior to the date
that the bonds are issued.) The Regulations are effective for
bonds issued after March 2, 1992, and apply for all purposes of
§ 103, not just for arbitrage purposes. Nonetheless, private
activity bonds, other than qualified § 501(c)(3) bonds, remain
subject to the requirements of Regulation § 1.103-8(a)(5) (the
"official action R,egulations"), so that official action under that
section is still required. On the other hand, proceeds of private
activity bonds which qualify as exempt facility bonds or small
issue bonds need only meet the requirements of the official
action Regulations and not the reimbursement Regulations in
order to be treated as expended.37 Nonetheless, there seems to
be some ambiguity over whether private activity bonds which
finance governmentally owned exempt facilities must meet
the requirements of the reimbursement Regulations in addi-
tion to the official action R,egulations, because the
, reimbursement Regulations expressly apply to private activ-
ity bonds that finance governmentally owned facilities.38
Generally, proceeds may be used to reimburse, and be
treated as spent on, expenditures made after the issuer
declares a reasonable intention to reimburse the expenditure
(the "official intent requirement"). The expenditure must be a
capital expenditure, and the bonds must be issued within one
year after the later of the date on which (1) the expenditure is
made, or (2) the property on which the expenditure is made is
placed in service.39
The official intent must be declared by the issuer or a
person designated by the issuer to make such declarations.
For this purpose "issuer" includes a conduit borrower, so that
a § 501(c)(3) organization can declare its own of�"icial intent;
however, because private activity bonda (other than qualified
§ 501(c)(3) bonds) must meet the requirements of Regulation
§ 1.103-8(a)(5), other conduit borrowers still need the political
subdivision issuer to take official action.
37 Reg§ 1.103-18(d), so long as certain antiabuse rules are not violated.
�Reg§ 1.103-18(c)(1)(iii).
39�g§ 1.103-18(c)(2)(i)—(iii).
9
0 1994 Clark Boardman Callaghan Pub 1?J94
�
GOVERNMENT DEBT FINANCING
The declaration must state that the declaration is
intended to serve as an expression of official intent. The state-,
ment must be made publicly available, and it must contain a
general description of the property on which the expenditures
will be made and the maximum amount that will be reim-
bursed with bond proceeds. Examples of a general description
include "highway capital improvements," "hospital equipment
acquisition," or"school building renovation."40 The description
will be sufficiently specific if it describes the fund from which
the expenditures will be made,for example, "parks and recrea-
tion fund—recreational facility capital improvement
program." However, the R,egulations require that the declara-
tion be reasonable and not a "blanket" declaration, made as a
matter of course or for amounts substantially in ezcess of
those reasonably necessary for a project.41
The reasonableness of the declaration depends on its
being consistent with the budgetary and financial circum-
stances of the issuer, in that no funds from sources other than
bond proceeds are expected to be reserved or allocated on a
long-term basis, or otherwise set aside by the issuer or related
- person, to finance the expenditure.42 Similarly, a pattern of
failure to reimburse expenditures for which official intent has
been declared can indicate the unreasonableness of the
declaration.�
The Regulations permit the official intent to be taken up
to 45 days after an emergency e�enditure is made. In addi-
tion, preliminary expenditures (such as architectural,
engineering, surveying, and bond issuance costs) for a project
financed with a bond issue that also finances actual costs of
the project may be reimbursed without a declaration of official
intent, so long as they do not exceed 20 percent of the issue
price of the portion of the bond issue that finances the
proj ect.�
40 R,eg§ 1.103-18(fl(2).
a�Reg§ 1.103-18(g)(3)(i)(A)•
az�g$ 1.103-18(g)(2)•
43 Reg§ 1.103-18(g)(3)(ii).
�Reg§ 1.103-18(i)(1), (2).
10
� + � , I
1992 SPECIAL SUPPLEMENT TO CHAPTER 7
The Regulations contain antiabuse rules that generally
limit the use of the bond proceeds which were allocated to the
reimbursed expenditures. For one year after the reimburse-
ment, such amounts may not be:
(i) deposited in a reserve or replacement fund,
ntal obli ation
(u) used to refund another governme g ,
(iii) deposited in a sinkin� fund (other than a bona fide debt
service fund) for any obligation of the issuer, or
(iv) used, at any time, to reimburse an expenditure already
financed with another obligation of the issuer.
An exception from requirements (i) and (iv) is provided for the
reimbursement of unforeseen expenditures of the proceeds of
the prior issue.� The Regulations expressly provide that pro-
ceeds of taxable bonds are subject to the same requirements as
tax-exempt bonds for reimbursement.�
The reimbursement Regulations apply to all bonds issued
after March 2, 1992; however, expenditures made between
September 9, 1989, and March 2, 1992, may be reimbursed so
long as there was some objective evidence that, at the time the
expenditure was made, the issuer expected to reimburse it
from either taxable or tax-exempt borrowing.47
Working Capital
Special rules are provided for the expenditure of working
capital. Worl�ng capital is treated as spent only after all other
available �unds of the issuer have been expended.� That is,
� gross proceeds may be allocated to worki�g capital expendi-
tures only to the egtent that working capital expenditures
exceed available amounts calculated as of that date. A list of
minor exceptions to this rule include: expenditures on issu-
ance costs, reasonable charges for qualified guarantees,
payments of principal or interest on refunded issue, payments
of principal or interest on a bond from a bona fide debt service
as Reg§ 1.103-18(k)(3}—(5).
as Reg§ 1.103-18(k}(2).
47Reg§ 1.103-18(1)(2).
48 Reg§ 1.148-4(d)(3)(i).
11
�1994 Clark Boardman Callaghan Pub 12J94
i
. �
r CU. ,w�,•, u �a,-��C --��f'►�^np'"'�
� n
CHAPTER 7
ARBITRAGE AND REFUNDINGS
by Dedn M. Weiner '
I. OVERVIEW AND HISTORY
§ 7:02. Historical Development of Arbitrage Restric-
tions. -
Delete second sentence of last paragraph and insert:
First, an exception to the rebate rules is permitted for
many bonds used to finance construction, if the bond proceeds
are expended within two years.
§ 7:07. Expenditure of Bond Proceeds and Invest-
ment Property.
Delete paragraph containing note 6 and substitute:
The Regulations provide that an expenditure of proceeds
held in a checking or similar account may be treated as made:
(a) on the date a negotiable check is written, if the check is
reasonably expected to be delivered or mailed no later than
three business days after that date, or(b) on the date the check
is delivered or mailed if the payor has no reason to believe that
the check will not clear within a reasonable time thereafter.s
6 Temp Reg § 1.148-4T(b), (c), and (d), as amended by TD 8345 (Apri125,
1991).
Delete sentence containing note 7 through end of para-
graph and delete following paragraph and substitute:
'O'Melveny & iVIyers, Los Angeles, California.
1
� � � .
§ 7:�7 GOVERNMENT DEBT FINANCING
The Treasury has proposed Regulations that clarify when
the allocation of bond proceeds to reimburse expenditures
made prior to the issuance of bonds is treated as an expendi-
ture.� Therefore, general requirements that must all be met in
order for reimbursement to qualify as an expenditure of bond
proceeds are:
(1} The issuer (which is defined to include the borrower
in a conduit financing) must declare a reasonable official
intent to reimburse the expenditure prior to making such
expenditure.
(2) : With limited exceptions for unexpected or prelimi-
nary expenditure, that official intent must be expressed no
more than two years prior to the date the expenditure is made.
;3),, The issuance of the bonds, with limited exceptions,
must occur within one year after the later of one year after the
date the expenditure is made or one year after the property is
placed in service.
(4) : The reimbursed expenditure must have been
incurred on property having a reasonably expected economic
life of at least one year (i.e., expenditures for working capital
may not be reimbursed).s
The Regulations require that the declaration of official
intent be made part of the publicly available official books and
records or proceedings of the issuer. In the case of a conduit
'�oorrower which expressed official intent, the intent must be
made available either on the public records, if any, of the
conduit borrower or on the official records of the proposed
issuer.
As the public availability of such records in the case of
conduit financings does not currently exist, new mechanisms
will have to be created to provide for such public availability.
The official intent must contain an expression of intent to
issue t�x-exempt bonds. It must indicate the source of funds
which will be used to make the initial expenditure and the
source of funds to be used to repay the bonds� Presumably,
these sources can be stated in quite a general fashion so that,
for eYample, a cond�ait borrower can simply express its intent
to pay from its general working capital and will issue bonds
payable from its general revenues.9 The official intent must
2
� ' � . �
CUMULATIVE SUPPLEMENT § 7:07
also include a general description of the property to be reim-
bursed including both the type of property and its,
appro�mate size or extent. Examples of such descriptions �
include 20 police cars, law enforcement equipment costing
$400,000.00, 5 x-ray machines, x-ray equipment costing
$20,000.00, $1,000,000 administration building, �liospital
equipment costing $20,000. Insubstantial deviations from
such description are not fatal, though the description appar- -
ently must be specific enough to allow a reasonable person to
conclude that the expenditures made were those which the
issuer intended to reimburse.9•��The most subjective portion of
the reimbursement Regulations requirements is that the
reimbursement must be consistent with the budgetary and
financial circumstances and availability of money of the
issuer.
The Regulations provide that "in general, a declaration of
official intent is not consistent with an issuer's budgetary and
financial circumstances if the issuer intends to reimburse an
expenditure for which funds (from sources other than the
reimbursement bond issue), at the time of the declaration of
official intent, are, or are reasonably expected to be, allocated
on a long-term basis, reserved, or otherwise available pursu-
ant to an issuer's budget."9•20 The Regulations provide an
example in which City B adopted a resolution that expressed
its official intent to reimburse itself for expenditures for an
athletic field. At the time of the expression of official intent, B
had a capital improvement fund in the amount of$1,000,000.
There was no legal requirement or other policy of B to reim-
burse the capital improvement fund and B had customarily
. paid for all capital expenditures of $500,000 or less out of its
capital improvement fund. B had budgeted only $100,000 of
expenditures from the capital improvement fund and had the '
policy of maintaining only $100,000 in the fund for emergen-
cies. The Regulations conclude that B's declaration of official
intent to reimburse the cost of the athletic field is not reasona-
ble because of the availability of the $800,000 in the capital
improvement fund. .
In another example, County C had budgeted $750,000 for
fire equipment improvements. C adopted a resolution author-
izing an expenditure of $500,000 for new fire trucks and
3
i �
�. t � . 1.
§ 7:�7 GOVERNMENT DEBT FINANCING
related fire safety equipment and to reimburse such expendi-
tures from bond proceeds. The Regulations conclude that C's
declaration of official intent to reimburse the expenditure for
the fire equipment is not reasonable because the expenditure
was provided for on C's budget. In a continuation of the preced-
in exam le C in h
t e alter
g p , , native, had not budgeted the
$500,000 for the fire equipment, but instead had budgeted the
$500,000 for other fire training equipment. Then C decided
not to incur the $500,000 of originally budgeted expenditures
for the training equipment, thus causing its intent to reim-
burse to be deemed unreasonable because its budget contained
$500,000 of funds available for the payment for the equipment
for which it had expressed its official intent. .
As the above examples indicate, it may be difficult to
determine for a large issuer exactly what funds the issuer may �
have available for the expenditures for which it had expressed
official intent. Often an issuer will have funds available for
emergencies or cash flow shortages, and it will not be clear
whether it should use such funds to pay for the capital expend-
itures for which it desires to express official intent. Policies of
political subdivisions change from time to time and there is
not an express policy for maintaining certain levels of monies
in particular funds. Discussions with the Internal Revenue
Service indicate that this rule probably will not apply unless
there is some nexus between the funds which are "available on
the long term basis" to finance a project and the amounts for
which the reimbursement is requested. The most difficult cir-
cumstance will arise with respect to political subdivisions that
maintain capital improvement funds, in particular, finding
what level of funding is normally maintained in such funds.9•3o
In addition to the budgetary consistency requirement,
there is a requirement that the political subdivision not have a
pattern of failing to reimburse for prior expenditures. This
provision is apparently intended to prevent a political subdivi-
sion from taking a broad official action expressing its intent to
reimburse all of its expenditures where the actual intent is
only to reimburse some smaller percentage of them. An issuer
is deemed not to have a pattern of failing to reimburse expend-
itures for which official intent has been declared if at least 75
percent of the expenditures that were actually paid by the
4
• � 1
� • l
CUMULATIVE SUPPLEMENT § 7:07
� issuer, for which expression of official intent had been
expressed, during the preceding three years, had been reim-
bursed by the issuer from the issuance of bonds. In
extraordinary circumstances, such as significant increases in
interest rates or unexpected reductions in credit worthiness of
the issuer, unreimbursed expenditures paid by the issuer and
for which official action was declared need not be taken into
account under this "75 percent safe harbor" rule. Also,
unreimbursed expenditures paid by the issuer and for which
official action was declared need not be counted, if there
remains time during a three-year period for such reimburse-
ment to occur.s.ao
The Regulations provide special rules with respect to cer-
tain "qualified preliminary expenditures" which allow official
intent to be declared at any time prior to the issuer incurring
such expenditures. Qualified preliminary expenditures are
the amount of expenditures up to 10 percent of the total costs
of the project, architectural engineering surveying, soil testing
and similar costs. In addition, in case a project is abandoned,
bonds need only be issued within one year after the date the
project or facility was abandoned or the date three years after
the last preliminary expenditure was paid.s.so
The Regulations include a broad definition of"issuer" for
purposes of the official action and include the issuer and all
persons related to the issuer both for purposes of expression of ,
official intent and for reviewing the reasonableness and budg-
etary consistency of the issuer's official action. The issuer
includes all members of the issuer's control group. "Control" is
defined as the right or power to control all or most of the
significant decisions or significant actions of the controlled
entity; the right or power to select, approve, disapprove or
remove without cause a controlling portion of the governing
body of the controlled entity; the right or power to determine
the budget or otherwise significantly control the finances of a
controlled entity, or the right or power to approve, disapprove
or prevent the issuance of debt obligations by the controlled
entity. Entities that are controlled by another entity are also
deemed to control all entities controlled by that entity. Similar
rules apply to a conduit borrower in a conduit financing.9•so
5
• � � �' • ,. t
§ 7:�7 GOVERNMENT DEBT FINANCING
Finally, the Regulations include a collection of anti-abuse
rules which provide that the bond proceeds received as a reim-
bursement may not be used:
(1) to refund another issue of tax-exempt governmental
obligations;
, (2) to create or increase the balance in the sinking fund
(other than a bona fide debt service fund);
. (3) to create or increase the balance in a reserve or
replacement fund; or
(4) to reimburse any expenditure or any payment with
respect to financing of an expenditure that was originally paid
with proceeds of any tax-exempt obligation of the issuer to any
person or entity other than the issuer (e.g., an interfund bor-
rowing) or any member of the same control group as the
issuer.9�70
The Regulations also provide that the existing re�ulations
under Regulation § 1.103-5(a)(5) continue to apply with
respect to tax-exempt bonds issued to reimburse expenditures
for exempt facility bonds and small issue bonds so long as the
project is not governmentally owned. If the project is govern-
mentally owned, then both the requirements of Regulation
� 1.103-8(a)(5) and the new Regulations must be satisfied. In
all cases, the anti-abuse rules must be satisfied.9�80
The Regulations are generally effective for all reimburse-
ment allocations of proceeds of reimbursement bonds made
with respect to obligations issued after September 7, 1991.
Furthermore, the basic requirements do not apply if:
(1) the expenditure was paid by the issuer after Septem-
ber 8, 1989, and before September 8, 1991;
(2) there is objective evidence that at the time the expen-
diture was paid, the issuer expected to reimburse the
e�penditure with proceeds of a borrowing (t�able or t�-
exempt); and
(3) the eYpenditure is consistent with the budgetary sta-
tus of the issuer. The anti-abuse rules will nonetheless apply
in all cases.s.90
�Prop Reg§§ 1.103-17 and 1.103-18 (Apri125, 1991).
8 Prop Reg§ 1.103-17(c)(1), (2), (3) and(4).
6
e � � F ` • . r � /
CUMULATIVE SUPPLEMENT § 724
9 Prop Reg§§ 1.103-17(e)(4) and(5).
9•10 Prop Reg§ 1.103-17(e)(3).
9•20 Prop Reg § 1.103-17(fl(2).
s.so prop Reg§ 1.103-17(f�(5); Examples 2, 3,4 and 5.
s.ao prop Reg§ 1.103-17(�(3).
s.so prop Reg§ 1.103-17(i).
e.so prop Reg§ 1.103-17(j).
9•70 Prop Reg§ 1.103-17(k).
9•80 Prop Reg§§ 1.103-18(a)and(b).
s.so prop Reg§ 1.103-17(1).
II. CONSTRUCTION AND ACQUISITION BONDS ,
§ 7:09. Original and Investment Proceeds—Defini-
tion.
§ 7:12. —Extended Temporary Periods and Tempo-
rary Periods for Pooled Financings.
At end of first full paragraph on page 54 add: '�•50
�i.5o For examples of rulings which permitted the e�ension of temporary
periods, see Ltr Ru18906040 (Nov. 15, 1988) and Ltr RuI 8910051 (Dec. 13,
1988).
§ 7:24. Separate Issues.
After paragraph containing note 8 add:
Recent private letter rulings have tended to aggregate
issues, at least for the purposes of private activity bond tests,
with unclear implications for the arbitrage rules. On the other
hand, a recent arbitrage ruling has indicated that the same
sources of security will not exist if two letters of credit, though
issued at the same time for the same parties, will not be
treated as a single source of security if the reimbursement
obligation under the letters of credit are secured on a nonre-
course basis from separate projects.8�5o
8•50 Ltr Rul 9008074 (Nov. 30, 1989); see Ltr Rul 9026010 (March 22,
1990), revoking 8302018 (Sept. 30, 1986); Ltr Ru19023019(March 7, 1990),
revoking 8402017 (Sept. 30, 1983) (regarding private activity bonds). �
7
_ y � �� � i �� �
§7:07 GOVERNMENT DEBT FINANCING
10Tax R,eform Act of 1986: Conference Committee Report, H Conf R.ep
841, 99th Cong, 2d Sess, II-746 (1986) [hereinafter cited TRA 86 Conference
Report].
��TRA 86 Conference Report II-?46.
t2The Joint Committee on Tagation stated, in the General Egplanation .
of the Tax Reform Act of 1986, that the 1986 Act "codifies the 'reasonable
expectations' test of prior law with respect to subsequent deliberate and
intentional acts to earn impermissible azbitrage taken subsequent to the
issuance of the bonds." To the extent the 1986 Act was intended simply to
codify prior law, issuers can perhaps continue to rely on prior law private letter
rulings (though private letter rulings cannot be cited as precedent) which
permit an issuer to continue to earn arbitrage after the three-year temporary
period is over, so long as the project is proceeding with due diligence, at least
with respect to bonds issued under prior law. Ltr Rul 8751059, Sept. 25, 1987.
The ability to so invest the proceeds of bonds issued under the 1986 Act is less
clear. See General Explanation of the Tax Reform Act of 1986, prepared by
the Staff of the Joint Committee on Taxation 1201 (1986).
13 Rev Rul 85-182, 1985-2 CB 39, and R,ev Rul 85-146, 1985-2 CB 38.
14See §7:04.
15In Rev Ru185-182, 1985-2 CB 39, a municipality issued bonds in order
to lend the proceeds to a developer to provide multi�amily housing. The
�nancing had been structured so that no disbursements could be made until an
alternative credit support could be found for the financing. If no alternative
support was found, then the bonds would be redeemed and the arbitrage
earned prior to such redemption would pay all cost of issuance. Finally, the
only amount expended prior to the issuance of bonds was a de minimis
amount expended to finance the acquisition of the land. The above facts led to
the conclusion that the expectation that the bond proceeds would be egpended
within three years was made in bad faith.
�BRev Ru185-146, 1985-2 CB 38. See also GCM 39409 (Sept. 13, 1985). It
seems surprising that any reference to ihe issuer's expecting not to call bonds
was made in the certi�cate. However, it seems reasonable to conclude that
such an expectation was implicit.
§7:0?. Egpenditure of Bond Proceeds and Investment
Property.
Before describing the impact of the regulations on various
types of financings, it is necessary to understand when bond
proceeds have been expended, because once expended they, of
course, are no longer subject to restriction. The regulations
define unspent pro�eeds of an issue as "the praceeds of such
issue minus e�penditures made with such proceeds other than
amounts expended on acquired purpose or nonpurpose obliga-
Chap 7—Page 34
' � . � '
ARBITR,AGE AND REFUNDINGS �7;07
tions."� That is, any use of bond proceeds other than the
acquisition of an investment is treated as an expenditure.
Though the definition of spent proceeds appears to apply a
direct tracing of proceeds because it refers to egpenditures made
� with "such" proceeds, the allocation rules do not require tracing,
except in limited circumstances.2 Generally, egpenditures may
be allocated to bond proceeds at any time and in any reasonably
consistent manner.3 The allocation of bond proceeds to expend-
itures or other uses may generally be made in any reasonable
manner. However, the Treasury is egpected to adopt rules that
"prevent avoidance of . . . restrictions through artificial alloca-
tions (or replacements) of bond proceeds." Unfortunately, no
guidance has been given regarding what will be considered an
"arti�cial allocation."4
The rebate regulations have reserved all sections regarding
the allocation of bond proceeds, other than rules dealing with
the allocation of expenditures from checking accounts and
certain specialized rules applicable to advance refundings.s
The regulations provide that an egpenditure of proceeds
held in a checking or similar account may be treated as made (a)
on the date a negotiable check is written if the check is delivered
or mailed no later than one business day after the date, or (b) on
the date the check is delivered or mailed if the payor has no
reason to believe that the check will not clear within a
reasonable time thereafter.6 This rule creates some difficulty for
political subdivisions as they rarely retain records indicating
the date on which a check is mailed. More frequently a political
subdivision will either know when a check is written or when it
clears. Either of such dates should be acceptable as the date of
the exp�nditure, so long as the political subdivision doea not
artificially date its checka early.
The allocation rules applicable to advance refundings will
be discussed in connection with a description of refunding
transactions.
One iasue which arises in this contegt is whether an issuer
may allocate the expenditure of bond proceeds to expenditures �
made prior to the issuance of the bonds. For example, assume
that, prior to issuing bonds, an issuer passes a resolution stating
that it will use bond proceeds to construct a city hall. Prior to
Chap 7—Page 35
�opyright �O 1989, Callaghan & Company Pub. 12/89
' " � � ,
$?:07 GOVERNMENT DEBT FINANCING
�
the issuance of the bonds, the issuer uses its working capital to
make substantial expenditures for engineering and design and
the acquisition of the land to be used for the city hall. The
issuer clearly should be able to issue bonds in an amount
sufficient to reimburse itself for the prior egpenditures and need �
not issue the bonds before it can start the city hall project.
Nonetheless, if the land for the city hall were acquired 20 years
prior to the bond issue, it is difficult to see how the political
subdivision can reasonably allocate the bond proceeds to the
expenditures for the land. The regulations do not provide any
direct guidance as to how the issuer may allocate the bond
proceeds to such pre-issuance expenditures. However, by anal-
ogy to the official action requirements used in the context of
private activity bonds,� it appears that egpenditures made after
the issuer has expressed its intent to finance a project with bond
proceeds may be reimbursed once the bonds are issued. Thus,
bond proceeds can be allocated to expenditures made in
anticipation of bond financing but prior to the issuance of the
bonds.e To continue the analogy, bond proceeds could not be
allocated to facilities which were placed in service more than
one year prior to the date the bonds were issued.
The preamble to the rebate regvlations state that the rules
for the allocation of proceeds to expenditures will provide that
proceeds of an issue that are not directly used to pay an
expenditure may be allocated to the expenditure, thus indicating
that some reimbursement will be permitted. However, the
preamble goes on to caveat that issuers should be aware that the
use of the proceeds of an issue to fund an investment fund does
not result in reduction in the amount of the unspent proceeds of
the issue. Thus, even if the proceeds were allocated to
egpenditures, rather than to investments in the fund, the
investments would still be allocated to bond proceeds if the
investment fund is a direct or indirect replacement fund for the
issue.9 This provision seems to indicate tha�t even if official
action were taken and the bond proceeds were allocated to
expenditures made after such official action, if the proceeds
were thereafter invested for an extended period of time, such
investments could be allocated to the bond proceeds and be
subject to arbitrage constraints.
Chap 7—Page 36
. - ♦ ' M
ARBITRAGE AND REFUNDINGS §7;07
It appears that the "expenditure" of bond proceeds means
that the iasuer is no longer benefitted by their investment. In
Revenue Ruling 80-257, the IRS took the position that, if the
issuer continues to bene�t from the investment of the funds, the
payment of the funds to a third party does not cause them to be
free of arbitrage limitations.��
Thus, the contribution of bond proceeds to the issuer's
pension plan was not an egpenditure of bond proceeds because
the isauer's future contributions to the plan would be reduced
depending on the earnings the pension plan received on the
investment of the contributed bond proceeds. On the other
hand, prior to the 1986 Act, if the issuer acquired an annuity
contract from an insurance company and contributed it to its
pension plan, the bond proceeds would be considered expended,
apparently because the investment egperience of the insurance
company is considered incidental to the shifting of the insur-
ance risk.
The 1986 Act substantially expanded the de�nition of the
investments subject to the arbitrage rules and thereby narrowed
the definition of egpenditure. The 1986 Act provides that bonds
will be arbitrage bonds if the proceeds are used to acquire higher
yielding investments; investments are defined as investment
property, including "any annuity contract, or any investment-
type property." As a result, the acquisition of an annuity
contract is not an egpenditure of bond proceeds. Unfortunately,
it is less clear what is included within "investment-type
property."
The 1986 Conference Report recites that it adopted the
House and Senate version of the bill and that investment-type
property includes any taxable property held for investment."
The 1986 House Report, as summarized in the 1986 Conference
Report, includes "other than customary prepaymenta"'� as
investment property. The inclusion of prepayments in invest-
ment-type property raises the issue of whether, for example, the
payment of a building contractor or vendor prior to delivery of
services or goods is an egpenditure or an investment. Deciding
the issue based on what is customary seems somewhat unsatis-
factory as customs change and are often ill-defined. For ezam-
ple, energy "capacity" (the right to receive energy in the future
Chap 7—Page 37
Copyright �O 1989, Callaghan & Company Pub. 12/89
' ' , � •
§?:07 GOVERNMENT DEBT FINANCING
from or to provide energy to a utility) may be paid for over time
or, at least occasionally, in advance; it is not clear how to
determine whether the advance payment is customary and,
therefore, when the bond proceeds are egpended.
The 1986 House R,eport does indicate that the acquisition
of real property and bond insurance is not an investment, but
what of leasehold interests or casualty insurance? All capital
expenditures are, in some sense, an investment or prepayment,
and issuers may have a difficult time determining when they
have made an investment, as opposed to an egpenditure, much
less the yield on such investment.13
There are a number of specific rules for the allocation of
obligations to bond proceeds. If the issuer holds a large number
of acquired obligations and has a large amount of unegpended
bond proceeds, the issuer may have to allocate its acquired
obligations to bond proceeds in order to determine, for egample,
the yield at which the bond proceeds are invested. Generally,
any allocation may be made so long as it is internally consistent.
However, there are some instances in which direct tracing is
required. Investments acquired with the original proceeds of
refunding bonds must be allocated to such proceeds, invest-
ments not purchased with the original proceeds of a refunding
bond cannot be allocated to such proceeds, investments pur-
chased with sinking fund proceeds must be allocated to such
proceeds, and if an investment is allocated to two or more
sources of funds, each receipt of principal and interest must be
allocated among such sources.14 Thus, the speci�c rules require
direct tracing in the cases involving sinking funds and refund-
ings.
Time and demand deposits are allocated to unspent pro-
ceeds to the extent such deposits are maintained for the purpose
of the issue.15 Finally, cash is not considered an investment.
Thus, it appears that an issuer can have more bond proceeds
than investments, but it is not clear how an issuer must allocate
its bond proceeds if it holds any of its funds in cash. On the
other hand, it is not clear whether coin and currency is the only
form of cash, or how an issuer otherwise holds cash.
Recently the allocation of investments has become particu-
larly important because the Internal Revenue Service has taken
Chap 7—Page 38
4 � J - �
ARBITRAGE AND REFUNDINGS �7;07
the position that certain amounts held by a political subdivi-
sion, which are neither pledged for the repayment of bond
proceeds nor acquired with bond proceeds, must nonetheless be
treated as bond proceeds.�• In R,evenue Ruling 82-101, a state
set aside certain funds for future use and used the earnings on
such funds to make payments on its bonds. The IRS concluded
that the funds were available to pay debt service on the bonds
even if the state encountered financial difficulty. Thus, the bond
proceeds replaced the funds which were invested at a materially
higher yield. The bonds were held to be arbitrage bonds. The
IRS has recently issued private letter rulings dealing with such
funds and has permitted the investments in such funds to be
allocated in any consistent way in order to avoid the bonds
being arbitrage bonds.��
In summary, political subdivisions often set bond proceeds
aside for future use, and, if such proceeds are subject to
restriction, the allocation of investments can be important. In
addition, in light of the ever-ezpanding definition of proceeds it
often becomes critical to deternaine which investments are
attributed to such proceeds and how long such proceeds remain
unezpended.
� Reg §1.103-13(�(1). Acquired nonpurpose obligations aze now referred
to in the statute as nonpurpose investments. IRC (1954) §148(�(6)(A).
2Reg §1.103-13(�(4).
3Reg §1.103-13(�(1). However, in TR,A 86 Conference Report II-753,
discussion of the safe-harbor esception to the rebate rules applicable to tag
anticipation notes, there is an indication that proceeds are egpended only as
the financed deficit arises. See §7:57.
4 General Ezplanation of the Taz Reform Act of 1986, prepared by the
Staff of the Joint Committee on Tazation 1204, n 159 (1986). See, however,
Temp R,eg §1.148-8T(d)(9)(i).
5 Temp R,eg §1.148-4T.
eTemp R,eg §1.148-4T(b), (c) and (d).
�E.g., R,eg §1.103-8(a)(5).
BSee Ltr Rul 8352087 (Sept. 30, 1983), bond proceeds used to reimburse
an issuer's ezpenditures made in anticipation of bond financing not subject to
yield restrictions.
9Preamble to Temp R,egs, TD 8252 (May 15, 1989), 54 Fed Reg 20787,
VIIIA; Ltr Rul 8923069 (March 16, 1989).
10R,ev Rul 80-257, 1980-2 CB 52, concluded that the proposed issuance
of bonds to make payments to the issuer's pension plan results in arbitrage
Chap 7—Page 39
Copyright �O 1989, Callaghan & Company Pub. 12/89
, . .
.� � ` .�►
§7:48 GOVERNMENT DEBT FINANCING
. �
bonds. The IRS reasoned that the issuer anticipated a substantial direct
benefit from the investment of the bond proceeds which were paid to the plan.
��TR.A 86 Conference Report II-747.
��TRA 86 Conference Report II-745.
General Esplanation of the Taz R,eform Act of 1986, prepared by the
Staff of the Joint Committee on Tazation 1202, n 154 (1986). � -
�3 See §§7:26 and 727.
14R,eg §1.103-13(f�(4). .
15Reg §1.103-13(�(3).
16See R,ev Rul 82-101, 1982-1 CB 21.
��See Ltr Ruls 8334103 (May 27, 1983) and 8322020 (Feb. 28, 1983).
II. CONSTRUCTION AND ACQUISITION BONDS
§7:08. Overview.
The arbitrage regulations were written prior to the 1986
Act, but continue to provide guidance to the principles used in
determining whether a bond is an arbitrage bond.�
The arbitrage regulations are divided into three basic
sections. Treasury Regulation § 1.103-13 deals primarily with
the general de�nitions and concepts applicable to all transac-
tiona. Treasury Regulation § 1.103-14 deals primarily with the
temporary periods and reserve funds permitted in connection
with the various types of financings. Temporary Treasury
Regulation § 1.103-15AT deals with the rebate provisions.
This part of this chapter deals with many of the general
concepts involved in all financings and will discuss in detail the
requirements for the most frequent type of financing—a con-
struction and acquisition financing. The common feature of
financings described in this part is the eligibility for the
temporary period described under Treasury Regulation
§ 1.103-14(b)(1)-(4), which, if its requirements are satisfied,
allows the original and investment proceeds of the bonds to be
invested without limitation for the first three years after the
bonds are issued. This section also deals with general sinking
fund rules, pledge and replacement funds, the requirements for �
the minor portion and reasonably required reserves, the concept
of overissuance, and multi-purpose and separate issues.
Other major types of financings described in later parts of
this chapter are refundings,2 and certain working capital
financings.3 Other parts of this chapter deal with specialized
Chap 7—Page 40