WASHINGTON -- Issuers of governmental and 501(c)(3) bonds should be eligible for arbitrage rebate relief under a 1989 law if they reasonably expect to spend 75% of their bond proceeds on construction, an American Bar Association subcommittee told the Treasury Department last week.

The group of lawyers, who are members of the association's committee on tax-exempt financing, urged the Treasury to adopt the reasonable expectations standard in a 26-page paper that contained recommendations for the Treasury to consider in writing rules for compliance with the two-year rebate relief law. The Treasury is expected to propose the rules later this month.

The need for the reasonable expectations standard surfaced last year after a congressional tax committee aide said the law applies only when issuers actually spend 75% of their bond proceeds on construction. Bond lawyers, however, have complained that this would be too restrictive and unrealistic and have insisted that Congress intended a reasonable expectations standard to apply.

The differences in interpretation stem from some ambiguous wording in the rebate relief law. The law, which was enacted in 1989 and amended in 1990, states that bond issues are eligible for an exemption from rebate under its provisions only if at least 75% of the available construction proceeds "are to be used" for construction expenditures.

Once eligible, issuers must spend certain percentages of their bond proceeds every six months over two years -- 10% in six months, 45% in a year, 75% in 18 months, and 100% in two years. But they may retain 5% of the proceeds for another year under certain circumstances.

The lawyers told Treasury in their paper that the determination of whether an issue is a construction issue under the law should be based on "the issuer's good-faith, reasonable expectations on the date of issuance."

An issuer should be allowed to certify at the time its bonds are issued that it expects to spend 75% of the proceeds on construction, they said. If the certification is made without reasonable basis, the issuer should be subject to criminal penalties and to tax shelter penalties under Section 6700 of the tax code that Congress applied to tax-exempt bonds in 1989.

The lawyers also urged Treasury to adopt a simple definition of construction in the rules. The suggested that construction be defined as "any integrated activity involving work normally requiring more than 60 days to complete." The 60 days should be counted from the date construction is ordered or the date it begins, whichever is later, they said.

For example, construction would include the purchase and installation of fixtures for a building, but not the purchase of furniture or equipment. The acquisition of custom-designed software or vehicles should qualify as construction, however, if the normal completion time was more than 60 days from when they were ordered, the lawyers said.

Construction could include subway cars, portable classrooms, transmission lines, fire trucks, computer hardware, a road, a rail line, a sewage line, or a program for the creation or refurbishment of a park, they said. However, the purchase of land or interests in land would not be considered construction, even if the land was financed with the proceeds of an issue that also financed construction of a building on the land.

The lawyers also said issuance expenses should be treated as "available construction proceeds" for purposes of determining whether an issue is a construction issue but not for purposes of complying with the spend-down requirements.

The rebate relief law currently excludes issuance expenses from available construction proceeds. But the lawyers said this "results in several practical problems," including the possibility that every bond issue otherwise qualifying as a construction issue would need to be split in two, with issuance expenses and a portion of each reserve fund being subject to rebate requirements from the date the bonds were issued.

The rebate relief law allows issuers to "bifurcate" an issue into construction and nonconstruction pieces to take partial advantage of the law's provisions.

The lawyers also recommended that issuers, in determining whether they have met the spend-down targets, be allowed to use the book value of their invested proceeds rather than the fair-market value. The book value would equal the amount of proceeds and earnings plus any accrued discount. The fair-market valued would be the value for which they could be sold that day.

The lawyers said the Treasury should be aware of a problem with the law's provisions for pooled financings, under which if one borrower fails to meet the spend-down requirements, all of the other borrowers do not automatically lose the benefits of the law.

The also recommended that Treasury allow trifurcation of multipurpose bond issues that finance new projects and refund previously issued bonds.

In a trifurcation, the refunding portion of the issue would be treated as a separate issue. The new-money portion would be bifurcated into a construction portion that would be subject to the rebate relief law and a non-construction portion that would not.

Other recommendations were made on election, spend-down, penalty and other requirements of the rebate relief law.

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