The IRS has released three "issue snapshots" relating to arbitrage rebate and yield reduction payment matters, including: (1) required payment dates for interim computation dates, (2) the next required computation date following use of an interim computation date, and (3) use of interim computation dates in late rebate calculations. The "issue snapshots" are aids created for IRS employees for certain technical issues, and include analysis of the covered issue and corresponding examiner guidance.

Background

Section 148 imposes arbitrage investment restrictions on the investment of proceeds of tax-exempt bonds and requires issuers to rebate certain excess earnings above the yield on those tax-exempt bonds to the federal government. In general, issuers must compute and make rebate payments in installments at least once every five years. An issuer may determine the next required computation date by reference to an interim rebate computation date for which the issuer makes a rebate payment.

Under Reg. Section 1.148-3(f)(1), the first rebate installment payment must be made for a computation date that is not later than five years after the issue date, and subsequent rebate installment payments must be made for a computation date that is not later than five years after the previous computation date for which an installment payment was made. A "computation date" is each date on which the issuer computes the rebate amount under Reg. Section 1.148-3(e). The yield on a variable yield issue is computed separately for each "computation period" (i.e., the period between computation dates).

Reg. Section 1.148-3(g) stipulates that each rebate payment must be paid not later than 60 days after the computation date to which the payment relates. An issuer may use more than one computation date in computing the rebate amount for a period, and a payment is not required within 60 days of an "interim computation date" (i.e., a computation date that is earlier than the latest permissible computation date) used in the calculation. The latest permissible computation date for the first rebate installment payment is not later than five years after the issue date and, for subsequent rebate installment payments, not later than five years after the previous computation date for which an installment payment was made.

Required payment dates for interim computation dates

The issue snapshot on interim computation dates covers the relationship between the required payment date for rebate or yield reduction payments and the use of interim computation dates as part of determining the amount of rebate or yield reduction payment.

After reviewing the relevant law and regulations, the issue snapshot sets forth "issue indicators or audits tips" for IRS employees. This guidance notes that issuers of a variable yield issue generally use interim computation dates in addition to the latest permissible computation dates to better match changes in bond yield with changes in the yield on investments, and to reduce the impact on the rebate amount resulting from decreased interest rates on the bonds during periods when the issuer no longer has significant invested gross proceeds.

The issue snapshot states that an issuer of a variable yield issue must use permitted computation dates in computing the rebate. It adds that each computation date (including interim computation dates) must be the end of a bond year, and must, after the first required payment date, be either the end of every bond year or the end of every fifth bond year.

Next required computation date

The issue snapshot on the next required computation date discusses the determination of the next required computation date following use of an interim computation date to determine the amount of rebate or yield reduction payment. Unlike the other two related issue snapshots, this issue snapshot does not include "issue indicators or audit tips." However, the issue snapshot does include some additional analysis of the relevant law. In its analysis, the issue snapshot notes that an interim computation date in connection with which the issuer does not make a payment, even if the rebate amount is $0 for such interim computation date, may not be the date from which the next required computation date is determined. A required computation date will be the date from which the next required computation date is determined.

Use of interim computation dates in late rebate calculations

The issue snapshot on late rebate calculations discusses the use of interim computation dates to determine the amount of rebate or yield reduction payment due when the payment is being made more than 60 days after the required computation date.

The "issue indicators or audit tips" for this snapshot state that, if an issuer under examination has not computed a rebate within the time required to make a timely payment of the rebate amount under Reg. Section 1.148-3(f)(1) (and the issue is not eligible for an exception to the rebate requirement), the examiner will generally allow a reasonable amount of time to compute the rebate amount. The guidance adds that the issuer may use interim computation dates in computing the rebate amount.

If the issuer does not compute the rebate amount within the period allowed, the issue snapshot states that the examiner will generally compute the rebate amount as of the applicable required computation date, without the use of any interim computation dates, and determine interest due on the late payment and penalty, as applicable. The issue snapshot adds that the examiner will communicate the resulting rebate amount to the issuer and, if the amount is positive, notify the issuer that a failure to pay the amount will result in the issuance of a proposed adverse determination relating to the tax-advantaged status of the bonds.

Implications

Tax Exempt and Government Entities issue snapshots have been a focus of the IRS to help provide concise analysis of specific issues commonly encountered during examinations. Each issue snapshot typically provides a summary of the legal framework governing the relevant issue and issue indicators or audit tips to provide guidance to IRS employees. These three recent snapshots focus on tax-exempt bond rebate and yield reduction computation dates and payments and provide insight to issuers as to the items of importance for the IRS on these matters.

Organizations that utilize tax-exempt debt can use these three recent issue snapshots as a reference for the required timing of arbitrage rebate computation dates and payments. Generally, issuers of tax-exempt bonds must calculate and pay arbitrage rebate and yield reduction payments, using Form 8038-T, within 60 days after every fifth anniversary of the issue date and the final payment of the bonds. If not, the bonds could be declared "arbitrage bonds" and thus taxable to the bondholders (i.e., the bondholder must include interest payments received on the "arbitrage bonds" in taxable income).

These issue snapshots reaffirm to the examiners the following:

— Variable rate bond issues can utilize interim computation dates to match changes in bond yield with changes in the yield on investments and thus minimize any rebate liability

— A rebate payment is generally allowed but not required after each interim computation date

— If a rebate payment is made within the first five years, then the first payment is considered timely, and then the next required payment is generally due five years after that first payment date

— In contrast, if an interim computation date does not have required payment, i.e. a negative calculation, then the next required computation date will be determined from the date of the required computation date, i.e., the end of fifth bond year or fifth year anniversary date

It should also be noted that the IRS appears to be granting some additional time to compute any potential rebate payments under exam. There does not appear to be any leniency, however, for late payment penalties and interest, if any would exist. There is not an exact amount of time granted to make this calculation. Furthermore, if there is no calculation produced within this "reasonable time", then the examiner is directed to generally compute the amount of rebate payment without considering the potential benefits of using interim calculations. Therefore, timely calculations would be most advantageous when preparing for an IRS exam, as well as to avoid penalties and interest.

Tax-exempt organization issuers should consider the guidance provided in the three issue snapshots previously described to gain additional insight regarding how the IRS determines the applicable rebate and yield reduction computation dates.

Please contact your Ernst & Young LLP tax professional with any questions.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg

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