WASHINGTON -- Municipal market participants cannot decide whether the Treasury and the Internal Revenue Service are playing Santa or Scrooge in pushing to simultaneously issue four major sets of rules before the end of the year.

On one hand, members of the bond community are anxious to see the details of the new rules, which will cover allocation and accounting for arbitrage purposes, refundings and transferred proceeds, the two-year rebate relief law, and reimbursement bonds.

However, they also want to enjoy the holidays without being forced to spend their time deciphering the new regulations.

The rules on allocation and accounting and the rabte relief law probably will be issued in proposed form, which would give market participants an opportunity to file written comments and appear at a public hearing before the rules become final, informed sources said. Agency officials would not confirm this.

However, it is not clear if the refunding and transferred proceeds rules will be issued in proposed form, because these rules will modify and add to rules that already exist, the sources said. The IRS has already said the reimbursement bond rules will be issued in final form and will become effective 30 days later.

The allocation and accounting rules are expected to chart the most new ground, the sources said. To do arbitrage rebate calculations, issuers must take into account the investment earnings on, and expenditures of, their bond proceeds. But arbitrage rebate rules issued in 1989 gave little guidance on this.

The allocation and accounting rules will provide such guidance, telling issuers when bond proceeds should be considered spent and how to account for earnings on bond proceeds while they remain unspent, according to sources.

One of the key issues to be addressed by the rules is how issuers should account for bond proceeds that are put into funds and comingled with other money. The rules also will tell issuers the extent to which investment earnings on investment earnings from bond proceeds in commingled funds will be excepted from yield restriction requirements. Arbitrage rules that have existed since the 1970s provided for such an exception but did not address commingled funds.

The rules on the two-year rebate relief law will tell issuers how to comply the law's requirements, the sources say. One major policy issue to be addressed by the rules is how construction should be defined so that issuers can determine which of their bond issues can be issued under the rebate relief law.

The rebate relief law, which was enacted by Congress in 1989, generally exempts issuers financing construction projects with governmental and 501(c)(3) bonds from arbitrage rebate requirements if they spend most of their proceeds within two years. The law applies to issues in which 75% of the proceeds are used for construction. But issuers want guidance on whether construction will cover subway cars or major computer equipment that would have to be especially designed and built for a subway system or a building.

The rules also are expected to help clear up confusion over the penalty that issuers, at the time of bond issuance, can elect to pay in case they fail to meet spend-down targets. One problem, for example, is that the law does not make clear that issuers that finish construction before the end of their two-year period must elect to state that their project is finished or see the earnings on their debt service reserve fund flow into the construction fund and be counted as unspent proceeds that are subject to penalty payments.

Under the rebate relief law, issuers must spend 10% of their proceeds within six months of issuance, 45% in one year, 75% in 18 months and 100% within two years, but may retain 5% for another year. The penalty is equal to 1.5% of the unspent proceeds under each six-month target and could continue until the issue is retired unless an issuer makes a special penalty termination payment.

The transferred proceeds rules are expected to modify and add to the transferred proceeds provisions of the arbitrage rebate rules that were enacted in 1989. These rules will provide guidance on the appropriate formula for figuring out the amount of proceeds that should be transferred in a refunding and how proceeds should be transferred in certain transactions such as partial refundings or refundings of pooled issues with multiple borrowers.

Under existing tax rules, the unspent proceeds of bonds being refunded must be transferred to, and become the proceeds of, the refunding bond issue as the refunding bond proceeds are used to pay debt service on the prior bonds. The yield of the transferred proceeds, when blended with the yield of the refunding bond proceeds, must not exxeed the yield of the refunding bonds.

Rules adopted in the 1970s allowed unspent proceeds to be transferred on a pro rata basis as principal was paid on the refunded bonds. But this led to abuse. In an effort to curb abuse, arbitrage rebate rules enacted in 1989 required that proceeds transfer as interest, as well as principal, was paid on the refunded bonds. But the rules eliminated the pro rata concept of the transfer.

The rules may fix what bond lawyers have charged is an unfair result of the 1989 rules -- the so-called killer suck-up rules, under which all of the unspent proceeds are "sucked up" and transferred to a refunding issue when only part of an issue is refunded.

Another issue raised by some bond lawyers that is not likely to be addressed in these rules is whether the transferred proceeds penalty should be eased for current refundings. Some lawyers have said the penalty is so onerous, particularly for refundings of high coupon bonds issued to refund low coupon bonds, that it discourages issuers from doing current refundings that would benefit Treasury by removing high coupon debt from the municipal market.

The penalty is the downward adjustment to the yield of the invested proceeds of the refunding bonds that typically is required for such refundings.

The final reimbursement rules are expected to address concerns raised about the proposed rules, which were issued last April and criticized as being overly restrictive and flawed. The final rules are expected to make compliance easier for issuers whose budgets are based on broad programs and that sell a bond issue to finance many projects.

The intent of the rules is to prevent issuers of governmental and 501(c)(3) bonds from using reimbursement bonds to skirt arbitrage restrictions. In a reimbursement financing, bond proceeds are used to reimburse the issuer for prior expenditures that were made with other funds. The bond proceeds are treated as spent as soon as the bonds are issued and can be invested without regard to arbitrage restrictions. The rules will make clear when reimbursement bond proceeds can be treated as spent and freely invested.

Under the proposed rules, an issuer must declare a "reasonable official intent" to reimburse within the two-year period before expenditures are made. He must issue the bonds either one year after expenditures are made or one year after the facility being financed is placed in service, whichever is later.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.