[Federal Register: July 16, 2007 (Volume 72, Number 135)]
[Rules and Regulations]
[Page 38767-38778]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16jy07-6]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9339]
RIN 1545-BG44
Qualified Zone Academy Bonds; Obligations of States and Political
Subdivisions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final and temporary regulations that
provide guidance to state and local governments that issue qualified
zone academy bonds and to banks, insurance companies, and other
taxpayers that hold those bonds on the program requirements for
qualified zone academy bonds. The temporary regulations implement the
amendments to section 1397E of the Internal Revenue Code (Code)
(discussed in this preamble) and provide guidance on the maximum term,
permissible use of proceeds, and remedial actions for qualified zone
academy bonds. The text of these temporary regulations also serves as
the text of the proposed regulations set forth in the notice of
proposed rulemaking on this subject in the Proposed Rules section in
this issue of the Federal Register. The portions of this rule that are
final regulations provide necessary cross-references to the temporary
regulations.
DATES: Effective Date: These regulations are effective on September 14,
2007.
Applicability Date: For dates of applicability, see Sec. 1.1397E-
1(m) of these regulations.
FOR FURTHER INFORMATION CONTACT: Timothy L. Jones or Zoran Stojanovic,
(202) 622-3980 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
These temporary regulations are being issued without prior notice
and public procedure pursuant to the Administrative Procedure Act (5
U.S.C. 553). For this reason, the collection of information contained
in these regulations has been reviewed, and pending receipt and
evaluation of public comments, approved by the Office of Management and
Budget under control number 1545-1908. Responses to this collection of
information are required to obtain or retain a benefit.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
For further information concerning this collection of information,
and where to submit comments on the collection of information and the
accuracy of the estimated burden, and suggestions for reducing this
burden, please refer to the preamble to the cross-referencing notice of
proposed rulemaking published in the Proposed Rules section of this
issue of the Federal Register.
Books and records relating to a collection of information must be
[[Page 38768]]
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
Section 1397E(a) of the Code provides that an eligible taxpayer
(within the meaning of section 1397E(d)(6)) that holds a qualified zone
academy bond (``QZAB'' or ``QZABs'') on a credit allowance date is
allowed a credit against Federal income tax for the taxable year that
includes the credit allowance date. In general, a QZAB is a bond issued
by a state or local government to finance certain eligible public
school purposes under section 1397E(d). Section 1397E(b) provides that
the amount of the QZAB credit equals the product of the credit rate and
the face amount of the bond held by the taxpayer on the credit
allowance date. Under section 1397E(b)(2), the credit rate is
determined by the Treasury Department and equals the percentage that
the Department estimates generally will permit the issuance of QZABs
without discount and without interest cost to the issuer. Section
1397E(i)(1) defines ``credit allowance date'' as the last day of the
one-year period beginning on the issue date of the issue and the last
day of each successive one-year period thereafter. Under section
1397E(d)(3), the maximum term of a QZAB is determined by the Treasury
Department and equals the term that the Treasury Department estimates
will result in the present value of the obligation to repay the
principal on the bond being equal to 50 percent of the face amount of
the bond.
Section 1397E(j) provides that the amount of the QZAB credit
allowed to the taxpayer is included in the taxpayer's gross income.
Section 1397E(e) imposes a national limitation on the amount of
QZABs that may be issued for each calendar year. The limitation is
allocated by the Treasury Department among the States on the basis of
their respective populations of individuals below the poverty line.
Section 1397E was amended by section 107 of the Tax Relief and
Health Care Act of 2006, Public Law 109-432, 120 Stat. 2922 (2006) (the
``2006 Act''), by adding certain requirements for a bond to be a QZAB.
In general, the 2006 Act added a new five-year spending period
requirement, arbitrage investment restrictions, and information
reporting requirements. Specifically, the 2006 Act added new section
1397E(f), which generally imposes spending period restrictions under
which an issuer of QZABs must reasonably expect, as of the issue date,
that: (1) At least 95 percent of the proceeds from the sale of the
issue are to be spent for one or more qualified purposes with respect
to qualified zone academies within the 5-year period beginning on the
issue date of the QZAB; (2) a binding commitment with a third party to
spend at least 10 percent of the proceeds from the sale of the issue
will be incurred within the six-month period beginning on the issue
date of the QZAB; and (3) such purposes will be completed with due
diligence and the proceeds from the sale of the issue will be spent
with due diligence. New Section 1397E(f)(2) added by the 2006 Act
provides authority to the Secretary of the Treasury to extend the five-
year spending period. To the extent that less than 95 percent of the
proceeds of the issue are spent within the five-year spending period
(plus any extension granted by the Secretary of the Treasury), the 2006
Act requires the issuer to redeem the nonqualified bonds within 90 days
after the end of such period.
In addition, the 2006 Act added new section 1397E(g), which
generally requires that an issue of QZABs must satisfy the arbitrage
investment restrictions of section 148 with respect to the proceeds of
the issue.
Finally, the 2006 Act added new section 1397E(h), which generally
requires that issuers of QZABs submit information reporting returns to
the IRS similar to the information reporting returns required to be
submitted to the IRS under section 149(e) for tax-exempt state or local
bonds.
Temporary regulations (TD 8755) interpreting section 1397E were
published on January 7, 1998 (63 FR 671), and amended on July 1, 1999
(TD 8826; 64 FR 35573). Final regulations under section 1397E (TD 8903)
were published on September 26, 2000 (65 FR 57732) (the ``Final
Regulations''). On March 26, 2004, a notice of proposed rulemaking
(REG-121475-03) was published in the Federal Register (69 FR 15747)
(the ``2004 Proposed Regulations''). The 2004 Proposed Regulations
proposed to amend the existing Final Regulations by providing guidance
on the maximum term, permissible use of proceeds, and remedial actions
for QZABs. A public hearing was scheduled for July 21, 2004. The public
hearing was cancelled because no requests to speak were received.
Written comments on the 2004 Proposed Regulations were received. After
consideration of the written comments, and in light of the statutory
changes made by the 2006 Act, the need for regulatory guidance on those
statutory changes, and the close connection between that needed
guidance and the guidance in the 2004 Proposed Regulations, the IRS and
the Treasury Department have determined to issue coordinated guidance
in these temporary regulations (the ``Temporary Regulations''), with an
opportunity for public comment in the corresponding proposed
regulations (the ``Proposed Regulations''). Set forth in this preamble
is an explanation of certain provisions of the Temporary Regulations.
Explanation of Provisions
I. Certain Definitions
A. In General
The Temporary Regulations employ certain definitions used in the
tax-exempt bond area. Thus, the Temporary Regulations employ certain
definitions used for general tax-exempt bond purposes in Sec. 1.150-1
and certain definitions used for purposes of the arbitrage investment
restrictions on tax-exempt bonds in Sec. 1.148-1(b).
B. Definitions of Various Types of Proceeds in General
In general, Sec. 1.148-1(b) defines ``sale proceeds'' as any
amounts actually or constructively received from the sale of an issue,
including amounts used to pay underwriters' discount or compensation.
In addition, Sec. 1.148-1(b) defines ``investment proceeds'' to mean
any amounts actually or constructively received from investing proceeds
of an issue. Further, Sec. 1.148-1(c) defines ``replacement proceeds''
to include certain amounts with a reasonable nexus to a bond issue,
such as sinking funds reasonably expected to be used to pay debt
service on a bond issue and pledged funds pledged to pay debt service
on a bond issue with a reasonable assurance that the funds will be
available to pay such debt service.
C. Proceeds for Purposes of the Use and Spending Requirements
In general, the Temporary Regulations provide that, for purposes of
the provisions of QZAB provisions regarding the use and expenditure of
proceeds for qualified purposes within prescribed periods, ``proceeds''
means sale proceeds, as defined in Sec. 1.148-1(b), plus investment
proceeds, as defined in Sec. 1.148-1(b). Thus, under the Temporary
Regulations, the requirement in section 1397E(d)(1)(A) to use at least
95 percent of the proceeds of an issue for a qualified purpose with
respect to a qualified zone academy applies by taking into account both
the sale
[[Page 38769]]
proceeds of the issue and any investment proceeds received from
investing those sale proceeds. Similarly, under the Temporary
Regulations, the requirement in section 1397E(f) to spend at least 95
percent of the proceeds from the sale of an issue on qualified purposes
within a five-year period and the associated requirements in section
1397E(f) apply to both sale proceeds of an issue and investment
proceeds derived from investing sale proceeds.
Some commentators suggested that, for purposes of the 95-percent
test, the definition of ``proceeds'' should be limited to sale proceeds
and should exclude amounts received from investing sale proceeds. These
commentators suggested that, when sizing a bond issue to comply with
the 95-percent test, it could be difficult for an issuer to include
investment earnings because interest rates may be volatile and the
timing of expenditures may be uncertain. The IRS and the Treasury
Department have considered this comment and have concluded that the
definition of proceeds in the 2004 Proposed Regulations that applies
for purposes of the 95-percent test is appropriate to ensure the use
and expenditures of proceeds of QZABs for one or more qualified
purposes under section 1397E(d)(5) and (f). Thus, the Temporary
Regulations retain this provision. This approach is consistent with the
view that, for purposes of certain similar provisions on qualified
private activity bonds under section 141, which are based on use of 95%
of the net proceeds, as defined in section 150(a)(3), for qualified
purposes, net proceeds properly include both sale proceeds and
investment proceeds pending expenditures for ultimate qualified
governmental purposes, with certain reductions inapplicable to QZABs.
D. Proceeds for Purposes of Private Business Contribution
Section 1397E(d)(1)(C)(ii) provides that a bond is a QZAB only if,
among other requirements, the issuer certifies that it has written
assurances that the private business contribution requirement of
section 1397E(d)(2) will be met with respect to the qualified zone
academy. Section 1397E(d)(2)(A) provides that the private business
contribution requirement is met if the eligible local education agency
that established the qualified zone academy has written commitments
from private entities to make qualified contributions (as defined in
section 1397E(d)(2)(B)) having a present value (as of the issue date of
the issue) of not less than ten percent of the proceeds of the issue.
The 2004 Proposed Regulations provide that, for purposes of the private
business contribution requirement of section 1397E(d)(2), proceeds
means sale proceeds, as defined in Sec. 1.148-1(b), without regard to
any investment proceeds received or expected to be received from
investing those sale proceeds. Commentators supported this narrower
definition of ``proceeds'' in the 2004 Proposed Regulations for
purposes of the private business contribution requirement. The
Temporary Regulations retain this provision.
II. Maximum Term
Section 1397E(d)(3) provides that the Secretary of the Treasury
Department shall determine, during each calendar month, the maximum
term for QZABs issued during the following calendar month. Section
1397E(d)(3) states that the maximum term shall be the term that the
Secretary estimates will result in the present value of the obligation
to repay the principal on the bond being equal to 50 percent of the
face amount of the bond. Section 1.1397E-1(d) of the existing Final
Regulations provides that the maximum term for a QZAB is determined
under section 1397E(d)(3) by using a discount rate equal to 110 percent
of the long-term adjusted applicable Federal rate (AFR), compounded
semi-annually, for the month in which the bond is issued. The IRS
publishes the long-term adjusted AFR each month in a revenue ruling.
See Sec. 601.601(d)(2)(ii)(b).
Section 1397E(b)(2) provides that the Secretary shall determine,
during each calendar month, a credit rate for QZABs issued during the
following calendar month. Section 1.1397E-1(b) provides that the
Secretary shall determine monthly (or more often as deemed necessary by
the Secretary) the credit rate the Secretary estimates generally will
permit the issuance of a QZAB without discount and without interest
cost to the issuer. Notice 99-35 (1999-2 CB 26), see Sec.
601.601(d)(2)(ii)(b) (``Notice 99-35''), indicates that, until further
notice, the credit rate for a QZAB will be published daily by the
Bureau of Public Debt on its Internet site for State and Local
Government Series securities (https://www.treasurydirect.gov). Notice
99-35 also provides that the credit rate shall be applied to a QZAB on
the first day on which there is a binding contract in writing for the
sale or exchange of the bond. Notice 99-35 states that the credit rate
will be determined by the Treasury Department based on its estimate of
the yield on outstanding AA rated corporate bonds of a similar maturity
for the business day immediately prior to the date on which there is a
binding contract in writing for the sale or exchange of the bond.
Prior to the issuance of the 2004 Proposed Regulations, questions
were raised regarding the maximum term of a QZAB that is sold in one
month and issued in another month. Section 1.1397E-1(d) of the existing
Final Regulations provides that the maximum term is determined based on
the month in which the bond is issued. However, under Notice 99-35, the
credit rate for a QZAB is determined based on the first day on which
there is a binding contract in writing for the sale or exchange of the
bond. The credit rate and maximum term should be determined on the same
day because the credit rate for a bond depends on its maximum term.
Accordingly, the 2004 Proposed Regulations would amend Sec. 1.1397E-
1(d) to provide that the maximum term for a QZAB is determined based on
the first day on which there is a binding contract in writing for the
sale or exchange of the bond.
Commentators supported the maximum term provisions in the 2004
Proposed Regulations. The Temporary Regulations retain these
provisions.
At the present time, the Treasury Department is continuing its
current practice of publishing the credit rate and maximum term for
QZABs on the Bureau of Public Debt's Internet site for State and Local
Government Series securities (http://www.publicdebt.treas.gov).
III. Use of Proceeds and Remedial Actions
A. In General
Section 1397E(d)(1) provides that a bond issued as part of an issue
is a QZAB only if, among other requirements, at least 95 percent of the
proceeds of the issue are to be used for a qualified purpose with
respect to a qualified zone academy established by an eligible local
education agency (as defined in section 1397E(d)(4)(B)) and the issue
meets the requirements of section 1397E(f) (relating to spending
periods), section 1397E(g) (relating to arbitrage), and section
1397E(h) (relating to information reporting requirements). Section
1397E(d)(5) defines ``qualified purposes'' for any qualified zone
academy to include: (i) Rehabilitating or repairing the public school
facility in which such academy is established, (ii) providing equipment
for use at such academy, (iii) developing course materials for
education to be provided at such academy, and (iv) training teachers
and other school personnel in such academy. Section 1397E(d)(4)(A)
[[Page 38770]]
defines ``qualified zone academy'' as any public school (or academic
program within a public school) that is established by and operated
under the supervision of an eligible local education agency to provide
education or training below the postsecondary level if: (1) The public
school or program is designed in cooperation with business in
accordance with section 1397E(d)(4)(A)(i); (2) students in the public
school or program will be subject to the same academic standards and
assessments as other students educated by the eligible local education
agency; (3) the comprehensive education plan of the public school or
program is approved by the eligible local education agency; and (4) the
public school is located in an empowerment zone or enterprise community
(as defined in section 1393), or there is a reasonable expectation (as
of the issue date of the bonds) that at least 35 percent of the
students attending the school or participating in the program will be
eligible for free or reduced-cost lunches under the school lunch
program established under the Richard B. Russell National School Lunch
Act.
B. Compliance With 95-Percent Test
1. In General
The 2004 Proposed Regulations provide guidance on compliance with
the 95-percent test in section 1397E(d)(1)(A). Specifically, the 2004
Proposed Regulations provide that, in general, an issue must satisfy
two requirements to comply with section 1397E(d)(1)(A). First, the
issuer must reasonably expect, as of the issue date of the issue, to
use at least 95 percent of the proceeds of the issue for a qualified
purpose with respect to a qualified zone academy for the entire term of
the issue (without regard to any redemption provision). Second, except
as otherwise provided in the remedial action provisions of the 2004
Proposed Regulations, at least 95 percent of the proceeds of the issue
must actually be used for a qualified purpose with respect to a
qualified zone academy for the entire term of the issue (without regard
to any redemption provision). For these purposes, under the 2004
Proposed Regulations, any unspent proceeds are treated as used for a
qualified purpose with respect to a qualified zone academy during any
period that the issuer reasonably expects that those proceeds will be
spent with due diligence for a qualified purpose with respect to a
qualified zone academy.
Some commentators suggested a modification of the requirement in
the 2004 Proposed Regulations that at least 95 percent of the proceeds
of an issue both be reasonably expected to be used and actually be used
for a qualified purpose for the entire term of the issue. Specifically,
these commentators requested that the requirement be altered to conform
to the tax-exempt bond provisions of Sec. 1.141-2(d), which look to a
similar standard based on reasonable expectations and deliberate
actions within an issuer's control, with certain exceptions for
involuntary conversions and actions in response to directives from the
Federal government. These commentators noted that use of the standards
under section 141 would be appropriate because the statutory language
of sections 141 and 1397E both use the phrase ``are to be used.'' In
substance, the standards for interpreting this phrase under the 2004
Proposed Regulations and under section 141 both incorporate reasonable
expectations and actual use, with certain special exceptions to actual
use in the case of the standard under section 141. The IRS and the
Treasury Department believe, however, that compliance standards for the
actual use of proceeds appropriately may take into account the
particular governmental program involved.
The Temporary Regulations do not adopt the suggestion to conform
the 95-percent test for QZABs to the deliberate action provisions of
Sec. 1.141-2(d). The Temporary Regulations retain the proposed
standard based on reasonable expectations and actual use. The actual
use test is set forth under section 1397E(f)(3), as introduced by the
2006 Act, and is appropriate for the circumstances involved with QZABs.
In addition, the control-based exceptions to actual use under the
deliberate action standard under section 141 raise certain
administrability concerns in the context of QZABs. For example, it may
be particularly difficult to determine if a loss of qualified zone
academy status is within an issuer's control.
The Temporary Regulations provide guidance on the spending period
requirements introduced by the 2006 Act in section 1397E(f).
Specifically, the Temporary Regulations provide that an issuer must
both reasonably expect to spend and actually spend at least 95 percent
of the proceeds of an issue of QZABs within the five-year period
beginning on the issue date of the issue of QZABs (or be subject to the
additional requirement to redeem bonds from unspent proceeds at the end
of that five-year period). The Temporary Regulations clarify that the
various requirements relating to ``reasonable expectations'' for the
use of proceeds of QZABs and actual actions to proceed with ``due
diligence'' to spend such proceeds on qualified purposes are based on
objective reasonableness standards, as used in the definition of
``reasonable expectations or reasonableness'' in Sec. 1.148-1(b) of
the arbitrage regulations.
2. Proceeds Spent for Rehabilitation, Repair or Equipment
Section 1397E(d)(5)(A) and (B) provides that the term ``qualified
purpose'' with respect to any qualified zone academy includes
rehabilitating or repairing the public school facility in which such
academy is established, and providing equipment for use at such
academy. The 2004 Proposed Regulations specify that, if proceeds of an
issue are spent for a purpose described in section 1397E(d)(5)(A) or
(B) with respect to a qualified zone academy, then those proceeds are
treated as used for a qualified purpose with respect to the academy
during any period after such expenditure that (1) the property financed
with those proceeds is used for the purposes of the academy and (2) the
academy maintains its status as a qualified zone academy. For this
purpose, the retirement from service of financed property due to normal
wear or obsolescence does not cause the property not to be used for a
qualified purpose with respect to a qualified zone academy.
The Temporary Regulations provide guidance on the applicable
standard for determining whether proceeds of QZABs are used for a
qualified purpose of ``rehabiliting'' a public school facility under
section 1397E(d)(5)(A), based on a known existing standard used for
purposes of the rehabilitation tax credit under section 47. In
particular, in determining whether proceeds of QZABs are used for a
qualified purpose of ``rehabilitating'' a public school facility under
section 1397E(d)(5)(A), rules similar to those used for purposes of the
rehabilitation tax credit in section 47(c) (other than sections
47(c)(1)(B) and 47(c)(2)(B)(v)) shall apply. Set forth in this preamble
is a general description of certain aspects of this rehabilitation
expenditure standard. In general, the rehabilitation standard under
section 47 requires a substantial rehabilitation involving a building
that already has been placed in service and a rehabilitation process
that preserves specified portions of the existing walls of the
building. Specifically, at least 50 percent of the existing external
walls of the rehabilitated building must be retained as external walls,
at least 75 percent of the existing external walls must be retained as
internal or external walls, and at least 75 percent of the
[[Page 38771]]
existing internal structural framework must be retained. Under this
rehabilitation standard, eligible rehabilitation expenditures include
some expenditures for reconstruction, subject, however, to the
foregoing restrictions on retention of certain percentages of the
existing walls. In addition, however, under this rehabilitation
standard, eligible rehabilitation expenditures do not include
expenditures to enlarge existing buildings or expenditures to acquire
existing buildings. In adopting the rehabilitation standard used in
section 47 for purpose of section 1397E, the IRS and the Treasury
Department declined to adopt one public comment which suggested that
rehabilitation should include complete reconstruction of a building.
Here, the IRS and the Treasury Department determined that such a broad
interpretation of rehabilitation effectively to include new
construction would be beyond Congressional intent.
3. Proceeds Spent to Develop Course Materials or Train Teachers
Section 1397E(d)(5)(C) and (D) provides that the term ``qualified
purpose'' with respect to any qualified zone academy includes
developing course materials for education to be provided at such
academy, and training teachers and other school personnel in such
academy. The 2004 Proposed Regulations provide that, if proceeds of an
issue are spent for a purpose described in section 1397E(d)(5)(C) or
(D) with respect to a qualified zone academy, then those proceeds are
treated as used for a qualified purpose with respect to the academy
during any period after such expenditure. Commentators supported this
provision of the 2004 Proposed Regulations. The Temporary Regulations
retain this provision.
4. Special Rule for Determining Status as Qualified Zone Academy
Section 1397E(d)(4)(A)(iv) provides that a public school (or
academic program within a public school) is a qualified zone academy
only if, among other requirements, the public school is located in an
empowerment zone or enterprise community, or there is a reasonable
expectation (as of the issue date of the issue) that at least 35
percent of the students attending the school or participating in the
program (as the case may be) will be eligible for free or reduced-cost
lunches under the school lunch program established under the Richard B.
Russell National School Lunch Act.
For purposes of determining whether an issue complies with section
1397E(d)(4)(A)(iv), the 2004 Proposed Regulations provide that a public
school is treated as located in an empowerment zone or enterprise
community for the entire term of the issue if the public school is
located in an empowerment zone or enterprise community on the issue
date of the issue. Commentators agreed with this provision of the 2004
Proposed Regulations relating to empowerment zones and enterprise
communities. The Temporary Regulations retain this provision.
Commentators also requested clarification of the relevant time
period for determining compliance with the 35-percent free or reduced-
cost school lunch program test. The Temporary Regulations provide that
the test looks to whether there is a reasonable expectation (as of the
issue date of the bonds) that at least 35 percent of the students
attending the school or participating in the program (as the case may
be) will be eligible for free or reduced-cost lunches during the one-
year period following the date the bonds are issued.
C. Remedial Actions
1. In General
Prior to the issuance of the 2004 Proposed Regulations, comments
were received requesting guidance specifying remedial actions that may
be taken to cure a violation of the 95-percent test in section
1397E(d)(1)(A). The 2004 Proposed Regulations specify two remedial
actions that may be taken in certain circumstances if less than 95
percent of the proceeds of an issue actually are used for a qualified
purpose with respect to a qualified zone academy. These remedial
actions are available only if the issuer reasonably expected on the
issue date of the bonds that: (1) The issue would meet the requirements
of section 1397E(f)(1)(A), (B), and (C); and (2) at least 95 percent of
the proceeds of the issue would be used for a qualified purpose with
respect to a qualified zone academy for the entire term of the issue
(without regard to any redemption provision).
As discussed in this preamble, the two remedial actions specified
in the 2004 Proposed Regulations are (1) redemption or defeasance of
the nonqualified bonds, and (2) alternative use of the disposition
proceeds. If the applicable requirements are met, the redemption or
defeasance remedial action is available to cure any failure to satisfy
the 95-percent test that was not reasonably expected as of the issue
date. The alternative use of disposition proceeds remedial action
applies only to certain dispositions of financed property for cash.
Commentators recommended that the 2004 Proposed Regulations be
amended to provide additional flexibility for issuers if the failure to
properly use proceeds is based on a loss of status of the public school
or academic program as a qualified zone academy. Consistent with the
2006 Act, the Treasury Department and the IRS have concluded that the
remedial actions of redemption and defeasance in the 2004 Proposed
Regulations will adequately address situations where there has been a
disqualifying change in the status of an academy. The Temporary
Regulations retain these two remedial actions with certain
modifications relating to the amendments to section 1397E introduced by
the 2006 Act.
2. Redemption or Defeasance of Nonqualified Bonds
Under the 2004 Proposed Regulations, a redemption or defeasance
remedial action is taken if: (1) All of the nonqualified bonds of the
issue (determined by applying the principles of Sec. 1.142-2(e)) are
redeemed within 90 days after the date on which the failure to properly
use proceeds occurs; (2) if any nonqualified bonds of the issue are not
redeemed within 90 days after the date on which the failure to properly
use proceeds occurs (the unredeemed nonqualified bonds), a defeasance
escrow is established for the unredeemed nonqualified bonds within 90
days after the date on which the failure to properly use proceeds
occurs; or (3) if the failure to properly use proceeds is a disposition
of financed property described in section 1397E(d)(5)(A) or (B) and the
consideration for the disposition is exclusively cash, all of the
disposition proceeds (as defined in Sec. 1.141-12(c)(1)) are used
within 90 days after the date of the disposition to redeem, or
establish a defeasance escrow for, a pro rata portion of the
nonqualified bonds of the issue.
The Temporary Regulations retain the remedial actions described in
this preamble but, in accordance with new section 1397E(f)(3), the
Temporary Regulations limit defeasance of nonqualified bonds to bonds
the proceeds of which have actually been spent for a qualified purpose
with respect to a qualified academy within the 5-year period beginning
on the issue date of the bonds. For proceeds that have not been spent
within the 5-year period, the only remedial action available to the
issuer is redemption of nonqualified bonds under the principles of
section 142.
[[Page 38772]]
3. Failure to Properly Use Proceeds
For unspent proceeds, the 2004 Proposed Regulations provide that a
failure to properly use proceeds occurs on the earlier of: (1) The
first date on which the public school (or academic program within the
public school) fails to constitute a qualified zone academy; or (2) the
first date on which the issuer fails to have a reasonable expectation
to proceed with due diligence to spend at least 95 percent of the
proceeds of the issue for a qualified purpose with respect to a
qualified zone academy.
The Temporary Regulations retain the provisions concerning the
failure to properly use unspent proceeds but implement section
1397E(f)(1)(A) by adding a provision that improper use also occurs if
95 percent of the bond proceeds have not been properly spent within the
5-year period beginning on the day the bonds are issued.
For proceeds that have been spent for rehabilitation, repair or
equipment described in section 1397E(d)(5)(A) or (B) with respect to a
qualified zone academy, the 2004 Proposed Regulations provide that a
failure to properly use proceeds occurs on the earlier of: (1) The
first date on which the public school (or academic program within the
public school) fails to constitute a qualified zone academy; and (2)
the first date on which an action is taken that causes the issuer to
fail actually to use at least 95 percent of the proceeds of the issue
for a qualified purpose with respect to a qualified zone academy. If
proceeds have been spent for course materials or training described in
section 1397E(d)(5)(C) or (D) with respect to a qualified zone academy,
no event subsequent to such expenditure shall constitute a failure to
properly use such proceeds under the 2004 Proposed Regulations.
4. Defeasance Escrow
The 2004 Proposed Regulations define ``defeasance escrow'' as an
irrevocable escrow established to retire bonds on the earliest call
date after the date on which the failure to properly use proceeds
occurs in an amount that is sufficient to retire the bonds on that call
date. At least 90 percent of the weighted average amount in a
defeasance escrow must be invested in investments (as defined in Sec.
1.148-1(b)), except that no amount in a defeasance escrow may be
invested in any investment the obligor (or any person that is a related
party with respect to the obligor within the meaning of Sec. 1.150-
1(b)) of which is a user of proceeds of the bonds. All purchases or
sales of an investment in a defeasance escrow must be made at the fair
market value of the investment within the meaning of Sec. 1.148-
5(d)(6).
Under the 2004 Proposed Regulations, the issuer must pay to the
United States, at the same time and in the same manner as rebate
amounts are required to be paid under Sec. 1.148-3 (or at such other
time or in such other manner as the Commissioner may prescribe), 100
percent of the investment earnings on amounts in the defeasance escrow.
For this purpose, the first computation period begins on the date on
which the failure to properly use proceeds occurs.
Under the 2004 Proposed Regulations, proceeds of QZABs (other than
unspent proceeds of the issue for which the failure to properly use
proceeds occurs) are not permitted to be used to redeem or defease the
nonqualified bonds. In addition, the issuer must provide written notice
to the Commissioner of the establishment of the defeasance escrow
within 90 days of the date the defeasance escrow is established.
Commentators suggested various modifications to the requirement
that issuers rebate to the United States 100 percent of the investment
earnings on amounts in a defeasance escrow. Alternative approaches
suggested by commentators included: (1) Limiting the rebate requirement
to investment earnings in excess of the yield on the issue of QZABs;
(2) limiting the rebate amount to investment earnings in excess of the
total debt service requirements to be paid out of the defeasance
escrow; and (3) limiting the rebate amount to the amount of the QZAB
credit.
The IRS and Treasury Department have concluded that the rebate
requirement should only apply to earnings in excess of the yield on the
issue of QZABs. Thus, the Temporary Regulations provide that the issuer
of QZABs with a defeasance escrow must rebate to United States any
investment earnings in the defeasance escrow that are in excess of the
yield, as defined in Sec. 1.148-1(b), on the issue of QZABs. For this
purpose, the credit rate for the QZAB issue is not included in the
yield on the issue.
Some commentators suggested that the first computation period for
rebate purposes begin on the date the defeasance escrow is established,
rather than the date on which the failure to properly use proceeds
occurs. These commentators noted that the 2004 Proposed Regulations
create a possible 90-day period during which an issuer would be
required to compute yield on an escrow that is yet to be established.
The Temporary Regulations adopt the change in start date for the
computation period in accordance with this comment.
One commentator recommended that certain small, low-wealth local
education agencies be exempt from the rebate requirement. The IRS and
the Treasury Department have considered this recommendation and have
concluded that the rebate requirement is appropriate to ensure
compliance with the 95-percent use-of-proceeds requirement of section
1397E(d)(1)(A), regardless of the size or wealth of the local education
agency. Thus, the Temporary Regulations do not adopt this
recommendation.
Some commentators suggested that the regulations provide that a
defeasance of a QZAB in the context of taking a remedial action not be
treated as a significant modification (within the meaning of Sec.
1.1001-3) and reissuance of the QZAB. The Temporary Regulations do not
address the circumstances in which a reissuance of a QZAB will occur.
The Temporary Regulations do provide, however, that, for purposes of
determining whether the establishing of a defeasance escrow as a
remedial action results in an exchange under Sec. 1.1001-1(a), the
QZAB is treated as a tax-exempt bond under Sec. 1.1001-
3(e)(5)(ii)(B)(1). Section 1.1001-3(e)(5)(ii)(B)(1) provides that a
defeasance of a tax-exempt bond is not a significant modification even
if the issuer is released from any liability to make payments under the
instrument if the defeasance occurs by operation of the terms of the
original bond and the issuer places in trust government securities or
tax-exempt government bonds that are reasonably expected to provide
interest and principal payments sufficient to satisfy the payment
obligations under the bond.
5. Alternative Use of Disposition Proceeds
The alternative use of disposition proceeds remedial action in the
2004 Proposed Regulations has four requirements. First, the failure to
properly use proceeds must be a disposition of financed property
described in section 1397E(d)(5)(A) or (B) and the consideration for
the disposition must be exclusively cash. Second, the issuer must
reasonably expect as of the date of the disposition that: (1) All of
the disposition proceeds, plus any amounts received from investing the
disposition proceeds, will be spent within two years after the date of
the disposition for a qualified purpose with respect to a qualified
zone academy; or (2) to the extent not expected to be so spent, used
within 90 days after the date of the disposition to take a redemption
or defeasance remedial action. Third, the disposition
[[Page 38773]]
proceeds, plus any amounts received from investing the disposition
proceeds, must be treated as proceeds for purposes of section 1397E.
Fourth, if all of the disposition proceeds, plus any amounts received
from investing the disposition proceeds, are not actually spent for a
qualified purpose within the two-year period beginning on the date of
the disposition (or used within 90 days after the date of the
disposition to take a redemption or defeasance remedial action), the
remainder of such amounts must be used within 90 days after the end of
that two-year period for a redemption or defeasance remedial action.
Some commentators recommended that the alternative use of
disposition proceeds remedial action be modified to provide that the
amounts relating to a disposition that are required to be spent for a
qualified purpose be capped at the principal amount of the QZAB
outstanding at the time of the disposition. The IRS and Treasury
Department have considered this comment and have concluded that the
requirement in the 2004 Proposed Regulations that all of the
disposition proceeds, plus any amounts received from investing the
disposition proceeds, be spent for a qualified purpose is appropriate
to ensure that QZABs are issued for qualified purposes. Thus, the
Temporary Regulations do not adopt this comment.
D. Payment of Principal, Interest or Redemption Price
The 2004 Proposed Regulations provide that the use of proceeds of a
bond to pay principal, interest, or redemption price of the bond or
another bond is not a qualified purpose within the meaning of section
1397E(d)(5). Thus, the use of proceeds of a bond to refund another bond
is not a qualified purpose under the 2004 Proposed Regulations. In
addition, the use of proceeds of a bond to fund a sinking fund to repay
the bond is not a qualified purpose under the 2004 Proposed
Regulations.
One commentator recommended that the 2004 Proposed Regulations be
modified to permit proceeds of a QZAB to be used to repay an interim
bridge loan incurred with the explicit intent to be refinanced with a
subsequent issuance. In response to this comment, the Temporary
Regulations provide an exception to the general rule that the use of
proceeds of a bond to pay principal, interest, or redemption price of
the bond or another bond is not a qualified purpose under section
1397E(d)(5).
IV. Arbitrage Investment Restrictions
New section 1397E(g) added by the 2006 Act provides that the
arbitrage requirements of section 148 applicable to tax-exempt state or
local governmental bonds under section 103 also apply to QZABs. The
Temporary Regulations provide guidance regarding the application of the
arbitrage requirements to QZABs.
In general, under section 148, subject to various prompt spending
exceptions (for example, the 18-month prompt spending exception to
arbitrage rebate for capital projects under Sec. 1.148-7(d) and the 2-
year construction spending exception to arbitrage rebate under section
148(f)(4)(C) and Sec. 1.148-7(e)) and other specified exceptions (for
example, the bona fide debt service exception for certain long-term
tax-exempt governmental, non-private activity bonds under section
148(f)(4)(A)), the arbitrage investment restrictions, including the
yield restrictions and the arbitrage rebate requirement, apply broadly
to ``gross proceeds'' of tax-exempt bonds. ``Gross proceeds''
represents a broad catch-all category of bond proceeds which includes
various subsidiary types of proceeds, including, among others, ``sale
proceeds'' derived from the sale of bonds, ``investment proceeds''
derived from investing proceeds of bonds, and ``replacement proceeds''
with a reasonable nexus to a bond issue (for example, sinking funds
reasonably expected to be used to pay debt service on bonds and pledged
funds used to secure bonds).
The Temporary Regulation provide that, except as otherwise
provided, the arbitrage investment restrictions under section 148 and
the exceptions to those restrictions apply to gross proceeds of QZABs
issued under section 1397E to the same extent and in the same manner as
they apply to gross proceeds of tax-exempt state or local governmental
bonds issued under section 103. For this purpose, references in the
arbitrage restrictions to tax-exempt bonds generally shall be deemed to
refer to QZABs and, to the extent that any particular arbitrage
restriction depends on whether bonds are private activity bonds under
section 141, the determination of whether QZABs are private activity
bonds shall be based on the general definition of private activity
bonds under section 141.
The Temporary Regulations provide limited guidance to tailor the
application of the arbitrage investment restrictions to QZABs in
certain specific respects. Thus, the Temporary Regulations provide that
a five-year temporary period exception to the arbitrage yield
restriction requirement applies to proceeds of QZABs if an issuer
reasonably expects to spend 95 percent of the proceeds of an issue of
QZABs for qualified purposes within the 5-year period beginning on the
issue date of the QZABs.
The Temporary Regulations provide that, in determining the yield on
an issue of QZABs for arbitrage purposes, the QZAB credit is
disregarded. Here, yield focuses on yield paid by the issuer on the
QZABs rather than the tax credit benefit to the investor.
The Temporary Regulations provide that the yield restriction rules
are inapplicable to amounts placed in defeasance escrow as a remedial
action. The Treasury Department and IRS have a concern that QZAB
issuers may be unable to find appropriate investments of the amounts in
the escrow at or below the yield on the bonds.
The Temporary Regulations provide that the exception to arbitrage
yield restriction for certain investments in non-AMT tax-exempt bonds
is inapplicable to QZABs. The IRS and the Treasury Department have a
concern about the clear arbitrage investment potential associated with
investing zero-yielding QZABs in non-AMT tax-exempt bond investments at
materially higher yields.
The Temporary Regulations provide that, in determining whether an
issue of QZABs qualifies for the small issuer exception to the
arbitrage rebate requirement under section 148(f)(4)(D), both QZABs and
tax-exempt bonds (other than private activity bonds) that are
reasonably expected to be issued or actually issued by the QZAB issuer
(and other covered on-behalf-of entities and subordinate entities)
within a calendar year are taken into account in measuring the
applicable size limitation.
Finally, consistent with the treatment of defeasance escrows for
purposes of yield restriction, in applying the small issuer exception
to the rebate of earnings from investments of amounts in a defeasance
escrow, the Temporary Regulations provide that the issuer is not
treated as a small issuer and amounts earned from such investments must
be rebated to the United States.
V. Information Reporting Requirement
Issuers of QZABs must submit information reporting returns to the
IRS similar to the information reporting returns required to be
submitted to the IRS under section 149(e) for tax-exempt State or local
bonds at the same time and manner as those reports are required to be
submitted to the IRS on
[[Page 38774]]
such forms as shall be prescribed by the Commissioner for such purpose.
Effective/Applicability Dates
In general, except as otherwise provided, the Temporary Regulations
apply to bonds sold on or after September 14, 2007.
In general, except as otherwise provided, Sec. 1.1397E-1(h)(2),
(i), and (j) of the Temporary Regulations regarding the five-year
spending period, the arbitrage investment restrictions, and the
information reporting requirement added by the 2006 Act apply to bonds
issued pursuant to allocations of the national qualified zone academy
bond volume cap authority arising in calendar years after 2005 and sold
on or after September 14, 2007.
Issuers and taxpayers may apply the Temporary Regulations in whole,
but not in part, to bonds sold before September 14, 2007.
Certain other special effective dates apply to particular
provisions under Sec. 1.1397E(m).
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. For
applicability of the Regulatory Flexibility Act, please refer to the
cross-reference notice of proposed rulemaking published elsewhere in
this Federal Register. Pursuant to section 7805(f) of the Code, this
regulation has been submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal authors of these regulations are Timothy L. Jones and
Zoran Stojanovic, Office of Division Counsel/Associate Chief Counsel,
IRS (Tax Exempt and Governmental Entities). However, other personnel
from the IRS and the Treasury Department participated in their
development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Amendments to the Regulations
0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding an
entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1397E-1T also issued under 26 U.S.C. 1397E. * * *
0
Par. 2. Section 1.1397E-1 is amended by:
0
1. Redesignating paragraphs (i), (j) and (k) as (k), (l) and (m),
respectively.
0
2. Adding new paragraphs (i) and (j).
0
3. Revising newly-designated paragraph (m).
The additions and revisions read as follows:
Sec. 1.1397E-1 Qualified zone academy bonds.
* * * * *
(i) and (j) [Reserved]. For further guidance, see Sec. 1.1397E-
1T(i) and (j).
* * * * *
(m) Effective/applicability dates. Except as provided in this
paragraph (m), this section applies to bonds sold on or after September
26, 2000. Each of paragraphs (c) and (k) of this section may be applied
by issuers to bonds that are sold before September 26, 2000.
0
Par. 3. Section 1.1397E-1T is added to read as follows:
Sec. 1.1397E-1T Qualified zone academy bonds (temporary).
(a) In general--(1) Overview. In general, a qualified zone academy
bond (QZAB or QZABs) is a taxable bond issued by a state or local
government the proceeds of which are used to improve certain eligible
public schools. An eligible taxpayer that holds a QZAB generally is
allowed annual Federal income tax credits in lieu of periodic interest
payments. These credits compensate the eligible taxpayer for lending
money to the issuer and function as payments of interest on the bond.
Accordingly, this section generally treats the allowance of a credit as
if it were a payment of interest on the bond. This section also
provides other rules for QZABs, including rules governing the credit
rate, the private business contribution requirement, the maximum term,
use and expenditure of proceeds, remedial actions, eligible issuers,
arbitrage investment restrictions, and information reporting.
(2) Certain definitions--(i) In general. For purposes of this
section, except as otherwise provided in this section, the following
definitions apply: the definitions set forth in this section; the
definitions used for general tax-exempt bond purposes in Sec. 1.150-1;
and the definitions used for purposes of the arbitrage investment
restrictions on tax-exempt bonds in Sec. 1.148-1(b).
(ii) Applicable definition of proceeds--(A) Use and expenditure
provisions. Except as provided in paragraphs (a)(2)(ii)(B) and
(a)(2)(ii)(C) of this section, for purposes of all applicable
requirements regarding use and expenditure of proceeds of QZABs under
section 1397E and this section, proceeds means ``sale proceeds,'' as
defined in Sec. 1.148-1(b), plus ``investment proceeds,'' as defined
in Sec. 1.148-1(b).
(B) Private business contribution requirement. For purposes of the
private business contribution requirement of section 1397E(d)(2),
proceeds means ``sale proceeds,'' as defined in Sec. 1.148-1(b).
(C) Arbitrage investment restrictions. For purposes of the scope of
application of the arbitrage investment restrictions under section
1397E(g) and paragraph (i) of this section, proceeds generally means
gross proceeds, as defined in Sec. 1.148-1(b). In addition, in
applying the arbitrage investment restrictions under paragraph (i) of
this section and section 148, the various applicable definitions of the
various types of proceeds of tax-exempt bonds under Sec. 1.148-1(b)
shall apply.
(b) and (c) [Reserved]. For further guidance, see Sec. 1.1397E-
1(b) and (c).
(d) Maximum term. The maximum term for a QZAB is determined under
section 1397E(d)(3) by using a discount rate equal to 110 percent of
the long-term adjusted applicable Federal rate (AFR), compounded semi-
annually, for the month in which the bond is sold. The Internal Revenue
Service publishes this figure each month in a revenue ruling that is
published in the Internal Revenue Bulletin. See Sec.
601.601(d)(2)(ii)(b) of this chapter. A bond is sold on the sale date,
as defined in Sec. 1.150-1(c)(6), which is the first day on which
there is a binding contract in writing for the sale or exchange of the
bond.
(e) through (g) [Reserved]. For further guidance, see Sec.
1.1397E-1(e) through (g).
(h) Use of proceeds--(1) In general. Section 1397E(d)(1) provides
that a bond issued as part of an issue is a QZAB only if, among other
requirements, at least 95 percent of the proceeds of the issue are to
be used for a qualified purpose with respect to a qualified zone
academy established by an eligible local education agency (as defined
in section 1397E(d)(4)(B)), and
[[Page 38775]]
the issue meets the requirements of section 1397E(f) and (g). Section
1397E(d)(5) defines qualified purpose, with respect to any qualified
zone academy, as rehabilitating or repairing the public school facility
in which such academy is established, providing equipment for use at
such academy, developing course materials for education to be provided
at such academy, and training teachers and other school personnel in
such academy. Section 1397E(d)(4)(A) defines qualified zone academy as
any public school (or academic program within a public school) that is
established by and operated under the supervision of an eligible local
education agency to provide education or training below the
postsecondary level and that meets the requirements of section
1397E(d)(4)(A)(i), (ii), (iii) and (iv).
(2) Use of proceeds requirements. An issue meets the requirements
of sections 1397E(d)(1)(A) and (f) only if--
(i) The issuer reasonably expects, as of the issue date of the
issue, that--
(A) At least 95 percent of the proceeds from the sale of the issue
are to be spent for 1 or more qualified purposes with respect to
qualified zone academies within the 5-year period beginning on the
issue date of the QZAB;
(B) A binding commitment with a third party to spend at least 10
percent of the proceeds from the sale of the issue will be incurred
within the 6-month period beginning on the issue date of the QZAB;
(C) At least 95 percent of the proceeds from the sale of the issue
will be spent for a qualified purpose with respect to a qualified zone
academy with due diligence (with due diligence measured by the
reasonableness standard under Sec. 1.148-1(b); and
(D) At least 95 percent of the proceeds of the issue will be used
for a qualified purpose with respect to a qualified zone academy for
the entire term of the issue (without regard to any redemption
provision); and
(ii) Except as otherwise provided in paragraph (h)(7) of this
section, at least 95 percent of the proceeds of the issue are actually
used for a qualified purpose with respect to a qualified academy for
the entire term of the issue (without regard to any redemption
provision).
(iii) Extension of 5-year period. The Commissioner may extend the
period described in paragraph (h)(2)(i)(A) of this section if the
issuer, prior to the end of such period, submits a private ruling
request, and establishes to the satisfaction of the Commissioner that--
(A) The failure to satisfy the 5-year spending requirement is due
to reasonable cause; and
(B) The expenditure of at least 95 percent of the proceeds from the
sale of the issue will be spent for a qualified purpose with respect to
a qualified zone academy will proceed with due diligence.
(3) Unspent proceeds. For purposes of paragraphs (h)(2)(i)(D) and
(h)(2)(ii) of this section, during the period described in paragraph
(h)(2)(i)(A) of this section, including any extension under paragraph
(h)(2)(iii) of this section, unspent proceeds are treated as used for a
qualified purpose with respect to a qualified zone academy if the
issuer reasonably expects to proceed with due diligence to spend those
proceeds for a qualified purpose with respect to a qualified zone
academy during that period.
(4) Proceeds spent for rehabilitation, repair or equipment--(i) In
general. Under section 1397E(d)(5)(A) the term qualified purpose with
respect to any qualified zone academy includes rehabilitating or
repairing the public school facility in which such academy is
established. For this purpose, in determining whether proceeds are
spent for rehabilitation, rules similar to those under section 47(c)
(other than sections 47(c)(1)(B) and 47(c)(2)(B)(iv)) shall apply.
Under section 1397E(d)(5)(B) the term qualified purpose also includes
providing equipment for use at such academy. If proceeds of an issue
are spent for a purpose described in section 1397E(d)(5)(A) or (B) with
respect to a qualified zone academy, then those proceeds are treated as
used for a qualified purpose with respect to the academy during any
period after such expenditure that--
(A) The property financed with those proceeds is used for the
purposes of the academy; and
(B) The academy maintains its status as a qualified zone academy
under section 1397E(d)(4).
(ii) Retirement from service. The retirement from service of
financed property due to normal wear or obsolescence does not cause the
property to fail to be used for a qualified purpose with respect to a
qualified zone academy.
(5) Proceeds spent to develop course materials or train teachers.
Section 1397E(d)(5)(C) and (D) provides that the term qualified purpose
with respect to any qualified zone academy includes developing course
materials for education to be provided at such academy, and training
teachers and other school personnel in such academy. If proceeds of an
issue are spent for a purpose described in section 1397E(d)(5)(C) or
(D) with respect to a qualified zone academy, then those proceeds are
treated as used for a qualified purpose with respect to the academy
during any period after such expenditure.
(6) Special rule for determining status as qualified zone academy.
Section 1397E(d)(4)(A)(iv) provides that a public school (or academic
program within a public school) is a qualified zone academy only if,
among other requirements, the public school is located in an
empowerment zone or enterprise community (as defined in section 1393),
or there is a reasonable expectation (as of the issue date of the
issue) that at least 35 percent of the students attending the school or
participating in the program (as the case may be) will be eligible for
free or reduced-cost lunches under the school lunch program established
under the Richard B. Russell National School Lunch Act. For purposes of
determining whether an issue complies with section 1397E(d)(4)(A)(iv)--
(i) A public school is treated as located in an empowerment zone or
enterprise community for the entire term of the issue if the public
school is located in an empowerment zone or enterprise community on the
issue date of the issue; and
(ii) The determination of whether there is a reasonable expectation
(as of the issue date of the issue) that at least 35 percent of the
students attending the school or participating in the program (as the
case may be) will be eligible for free or reduced-cost lunches under
the school lunch program established under the Richard B. Russell
National School Lunch Act is based on expectations regarding the one-
year period following the issue date.
(7) Remedial actions--(i) General rule. If less than 95 percent of
the proceeds of an issue are properly used (as determined under
paragraph (h)(7)(ii)(D) of this section), the issue will be treated as
meeting the requirements of section 1397E(d)(1)(A) if the issue met the
requirements of paragraph (h)(2)(i) of this section and a remedial
action is taken under paragraph (h)(7)(ii) or (iii) of this section.
(ii) Redemption or defeasance--(A) In general. A remedial action is
taken under this paragraph (h)(7)(ii) if the requirements of paragraphs
(h)(7)(ii)(B) and (C) of this section are met.
(B) Retirement of nonqualified bonds--(1) In general. The
requirements of this paragraph (h)(7)(ii)(B) are met if--
(i) All of the nonqualified bonds of the issue (determined by
applying the
[[Page 38776]]
principles of Sec. 1.142-2(e)) are redeemed within 90 days after the
date on which the failure to properly use proceeds occurs; or
(ii) To the extent of proceeds of the issue that have been actually
spent for a qualified purpose with respect to a qualified zone academy,
if any nonqualified bonds of the issue are not redeemed within 90 days
after the date on which the failure to properly use such proceeds
occurs (the unredeemed nonqualified bonds), a defeasance escrow is
established for the unredeemed nonqualified bonds within 90 days after
the date on which the failure to properly use proceeds occurs.
(2) Special rule for dispositions for cash. If the failure to
properly use proceeds is a disposition of financed property described
in section 1397E(d)(5)(A) or (B) and the consideration for the
disposition is exclusively cash, the requirements of this paragraph
(h)(7)(ii)(B) are met if all of the disposition proceeds (as defined in
paragraph (h)(7)(iv) of this section) are used within 90 days after the
date of the disposition to redeem, or establish a defeasance escrow
for, a pro rata portion of the nonqualified bonds of the issue.
(3) Definition of defeasance escrow. For purposes of this section,
a defeasance escrow is an irrevocable escrow established to retire
nonqualified bonds on the earliest call date after the date on which
the failure to properly use proceeds occurs in an amount that is
sufficient to retire nonqualified bonds on that call date. At least 90
percent of the weighted average amount in a defeasance escrow must be
invested in investments (as defined in Sec. 1.148-1(b)), except that
no amount in a defeasance escrow may be invested in any investment the
obligor (or any person that is a related party with respect to the
obligor within the meaning of Sec. 1.150-1(b)) of which is a user of
proceeds of the bonds. All purchases or sales of an investment in a
defeasance escrow must be made at the fair market value of the
investment within the meaning of Sec. 1.148-5(d)(6).
(C) Additional rules--(1) Limitation on source of funding. Proceeds
of an issue of QZABs (other than unspent proceeds of the issue for
which the failure to properly use proceeds occurs) must not be used to
redeem or defease nonqualified bonds under paragraph (h)(7)(ii)(B) of
this section.
(2) Rebate requirement. The issuer must pay to the United States,
at the same time and in the same manner as rebate amounts are required
to be paid under Sec. 1.148-3 (or at such other time or in such other
manner as the Commissioner may prescribe), any investment earnings on
amounts in a defeasance escrow established under paragraph
(h)(7)(ii)(B) of this section that are in excess of the yield on the
issue of QZABs with respect to which the defeasance escrow was
established. For this purpose, the first computation period begins on
the date on which the defeasance escrow is established.
(3) Notice of defeasance. The issuer must provide written notice to
the Commissioner, at the place designated in Sec. 1.150-5(a), of the
establishment of the defeasance escrow within 90 days of the date the
defeasance escrow is established.
(D) When a failure to properly use proceeds occurs--(1) Unspent
proceeds. For unspent proceeds, a failure to properly use proceeds
occurs on the earlier of--
(i) The first date on which the public school (or academic program
within the public school) fails to constitute a qualified zone academy;
(ii) The first date on which the issuer fails to have a reasonable
expectation to proceed with due diligence to spend at least 95 percent
of the proceeds of the issue for a qualified purpose with respect to a
qualified zone academy; or
(iii) The last day of the period described in paragraph
(h)(2)(i)(A) of this section, including any extension, if less than 95
percent of the proceeds of the issue are actually spent for a qualified
purpose with respect to a qualified zone academy.
(2) Proceeds spent for rehabilitation, repair or equipment. For
proceeds that have been spent for a purpose described in section
1397E(d)(5)(A) or (B) with respect to a qualified zone academy, a
failure to properly use proceeds occurs on the earlier of--
(i) The first date on which the public school (or academic program
within the public school) fails to constitute a qualified zone academy;
and
(ii) The first date on which an action is taken that causes the
issuer to fail to actually to use at least 95 percent of the proceeds
of the issue for a qualified purpose with respect to a qualified zone
academy.
(3) Proceeds spent for course materials or training. If proceeds
have been spent for a purpose described in section 1397E(d)(5)(C) or
(D) with respect to a qualified zone academy, no event subsequent to
such expenditure shall constitute a failure to properly use such
proceeds.
(iii) Alternative use of disposition proceeds. A remedial action is
taken under this paragraph (h)(7)(iii) if all of the requirements of
paragraphs (h)(7)(iii)(A) through (D) of this section are met--
(A) The failure to properly use proceeds (as determined under
paragraph (h)(7)(ii)(D) of this section) is a disposition of financed
property described in section 1397E(d)(5)(A) or (B) and the
consideration for the disposition is exclusively cash;
(B) The issuer reasonably expects as of the date of the disposition
that--
(1) All of the disposition proceeds will be spent within the two-
year period beginning with the date of the disposition for a qualified
purpose with respect to a qualified zone academy; or
(2) To the extent not expected to be so spent, the disposition
proceeds will be used within 90 days after the date of the disposition
to redeem or defease bonds in a manner that meets the requirements of
paragraph (h)(7)(ii) of this section;
(C) The disposition proceeds are treated as proceeds for purposes
of section 1397E; and
(D) If all of the disposition proceeds are not actually used in the
manner described in paragraph (h)(7)(iii)(B) of this section, the
remainder of such amounts are used within 90 days after the end of the
period described in paragraph (h)(7)(iii)(B)(1) of this section for a
remedial action that meets the requirements of paragraph (h)(7)(ii) of
this section.
(iv) Definition of disposition proceeds and allocation among
multiple funding sources. For purposes of this paragraph (h)(7),
disposition proceeds means disposition proceeds, as defined in Sec.
1.141-12(c)(1), plus amounts derived from investing disposition
proceeds. If property has been financed with an issue of QZABs and one
or more other funding sources, any disposition proceeds from that
property are allocated to the issue under the principles of Sec.
1.141-12(c)(3).
(8) Payment of principal, interest or redemption price--(i) In
general. Except as provided in paragraphs (h)(8)(ii) and (h)(8)(iii) of
this section, the use of proceeds of a bond to pay principal, interest,
or redemption price of the bond or another bond is not a qualified
purpose within the meaning of section 1397E(d)(5).
(ii) Exception for certain eligible reimbursements of interim
refinancings. The use of proceeds of a bond (the refinancing bond) to
pay principal, interest or redemption price of another bond (the prior
bond) is a qualified purpose within the meaning of section 1397E(d)(5)
to the extent that--
(A) The prior bond was not a QZAB (and, in the case of a series of
[[Page 38777]]
refinancings, no earlier bond in the series was a QZAB);
(B) The proceeds of the prior bond (or the original bond in the
case of a series of refinancings, as applicable) were spent for a
qualified purpose under section 1397E(d)(5) (the original expenditure);
and
(C) The issuer makes a valid reimbursement allocation to allocate
the proceeds of the refinancing bond to the payment of the original
expenditure (the reimbursement allocation), which allocation satisfies
the requirements for reimbursements under paragraph (h)(9) of this
section. For purposes of applying the rules for reimbursement, a
refinancing bond which otherwise meets the requirements of this
paragraph (h)(8)(ii) is eligible for reimbursement and is not treated
as a disqualified refunding under Sec. 1.150-2(g).
(iii) Reissuance of a QZAB. For purposes of determining whether the
establishing of a defeasance escrow under paragraph
(h)(7)(ii)(B)(1)(ii) of this section results in an exchange under Sec.
1.1001-1(a), the QZAB is treated as a tax-exempt bond under Sec.
1.1001-3(e)(5)(ii)(B)(1).
(9) Reimbursement. An expenditure for a qualified purpose may be
reimbursed with proceeds of a QZAB. For this purpose, rules similar to
those on reimbursement of expenditures in Sec. 1.142-4(b) and Sec.
1.150-2 shall apply. In applying these reimbursement rules,
expenditures eligible for reimbursement under Sec. 1.150-2(d)(3) shall
be deemed to mean any expenditure for a qualified purpose under section
1397E(d)(5).
(i) Arbitrage investment restrictions--(1) In general. Under
section 1397E(g) and this paragraph (i), and except as otherwise
provided in this paragraph (i), the arbitrage investment restrictions
and rebate requirements under section 148 and Sec. 1.148-1 to Sec.
1.148-11, inclusive, and the exceptions to those restrictions, apply
broadly to gross proceeds of QZABs issued under section 1397E to the
same extent and in the same manner as they apply to gross proceeds of
tax-exempt state or local governmental bonds. For this purpose,
references in those sections to tax-exempt bonds generally shall be
deemed to refer to QZABs and, to the extent that any particular
arbitrage restriction depends on whether bonds are private activity
bonds under section 141, the determination of whether QZABs are private
activity bonds shall be based on the general definition of private
activity bonds under section 141. In applying section 148 and the
regulations under that section to QZABs, the modifications set forth in
paragraphs (i)(2) through (6) of this section shall apply.
(2) 5-year temporary period exception to arbitrage yield
restriction. If an issue of QZABs meets the requirements of section
1397E(f)(1) and paragraph (h)(2)(i) of this section, then the proceeds
of the issue of QZABs are treated as qualifying for a 5-year temporary
period exception to arbitrage yield restriction under Sec. 1.148-
2(e)(2) beginning on issue date of the issue.
(3) Disregard QZAB credit in QZAB yield for arbitrage purposes. In
determining the yield on an issue of QZABs for arbitrage purposes under
Sec. 1.148-4, the QZAB credit allowed under section 1397E(a) is
disregarded.
(4) Non-AMT tax-exempt bond investment exception inapplicable. The
exception to arbitrage yield restriction for investments of gross
proceeds of tax-exempt bonds in specified tax-exempt bond investments
not subject to section 148(b)(3)(B) (relating to an exception to the
definition of ``investment property'' for specified tax-exempt bonds)
and Sec. 1.148-2(d)(2)(v) (relating to a corresponding exception to
arbitrage yield limitations) is inapplicable.
(5) Application of small issuer exception to the arbitrage rebate
requirement. Except as otherwise provided in paragraph (i)(6) of this
section, for purposes of the small issuer exception to the arbitrage
rebate requirement under section 148(f)(4)(D) and Sec. 1.148-8, both
QZABs and tax-exempt bonds (other than private activity bonds) that are
actually issued or reasonably expected to be issued by the QZAB issuer
(and applicable entities aggregated under section 148(f)(4)(D)) within
a calendar year are taken into account in measuring the applicable size
limitation.
(6) Certain defeasance escrow earnings. With respect to a
defeasance escrow established in a remedial action for an issue of
QZABs that meets the special rebate requirement under paragraph
(d)(7)(ii)(C)(2) of this section, the QZAB issuer is treated as
ineligible for the small issuer exception to arbitrage rebate under
section 148(f)(4)(D) and paragraph (i)(5) of this section and
compliance with that special rebate requirement is treated as
satisfying applicable arbitrage investment restrictions under section
148 for that defeasance escrow.
(j) Information reporting requirement. Under section 1397E(h) and
this paragraph (j), issuers of QZABs are required to submit information
reporting returns to the IRS similar to the information reporting
returns required to be submitted to the IRS under section 149(e) for
tax-exempt state or local governmental bonds at the same time and in
the same manner as those reports are required to be submitted to the
IRS on such forms as shall be prescribed by the Commissioner for such
purpose.
(k) and (l) [Reserved]. For further guidance, see Sec. 1.1397E-
1(k) and (l).
(m) Effective/applicability dates--(1) In general. Except as
otherwise provided in this paragraph (m), this section applies to bonds
sold on or after September 14, 2007.
(2) Special effective dates--(i) Effective dates for paragraphs
(h)(2), (i), and (j) of this section in general. Paragraphs (h)(2),
(i), and (j) of this section apply to bonds issued pursuant to
allocations of the national qualified zone academy bond volume cap
authority for calendar years after 2005 and sold on or after September
14, 2007.
(ii) Permissive retroactive application--(A) In general. Except as
otherwise provided in this paragraph (m), issuers and taxpayers may
apply this section in whole, but not in part, to bonds sold before
September 14, 2007.
(B) Special rule for certain provisions. For purposes of the
permissive retroactive application rule in paragraph (m)(2)(ii)(A) of
this section, paragraphs (h)(2), (i), and (j) of this section need not
be applied to any bonds to which those provisions do not otherwise
apply under the general effective date provisions for those provisions
in paragraph (m)(2)(i) of this section.
(C) Definition of proceeds. Issuers and taxpayers may apply
paragraphs (d) and (h) of this section, without regard to the
definition of proceeds in paragraph (a)(2)(ii) of this section, to
bonds sold before September 14, 2007.
(D) Bonds issued before July 1, 1999. Paragraphs (d) and (h)(9) of
this section may not be applied to bonds issued before July 1, 1999.
(3) Expiration date. The applicability of this section expires on
or before July 13, 2010.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
0
Par. 4. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
0
Par. 5. In Sec. 602.101, paragraph (b) is amended by adding the
following entry in numerical order to the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(b) * * *
[[Page 38778]]
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
* * * *
1.1397E-1T................................................. 1545-1908
* * * *
------------------------------------------------------------------------
Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
Approved: July 3, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E7-13665 Filed 7-13-07; 8:45 am]
BILLING CODE 4830-01-P