WASHINGTON -- The Treasury plans to fix a glitch in the proposed reimbursement rules that would prohibit issuers from using tax-exempt bond proceeds to reimburse themselves for any issuance costs they paid before the bonds were issued, a Treasury official said yesterday.

The proposed rules as written do not allow issuance costs to be reimbursement because only expenditures that are capitalized to the project, or that are included in the cost of the project for tax purposes, are reimbursable.

Issuance costs are capitalized to the debt, not the project, and are amortized over the term of the loan. So under the proposed rules, bond proceeds intended to reimburse these costs would not be treated as spent and would be subject to arbitrage restrictions.

"It was just a technical oversight. We certainly didn't intend to exclude these costs," said David A. Walton, Treasury's attorney-adviser on tax-exempt bonds. "We fully intend to fix it," he added.

Perry E. Israel, a partner with Orrick, Herrington & Sutcliffe in San Francisco, pinpointed the glitch in a recent letter to Mr. Walton.

The glitch occurred when Treasury, in the proposed rules, tried to help issuers distinguish which expenditures could be reimbursed with bond proceeds, according to Mr. Israel and department officials.

The rules said that reimbursement bond proceeds would be treated as spent and would therefore not be subject to arbitrage restrictons, if the expenditures being reimbursed were "incurred with respect to property having a reasonably expected economic life of at least [one] year."

The purpose of this language, according to Treasury officials, was to prevent issuers from using tax-exempt bonds to reimburse for working capital expenditures such as salaries or other current operating expenses.

The proposed rules, however, said property would be deemed to have a reasonably expected economic life if it were "properly chargeable to, or... capitalized as part of the basis, of the facility," and if the issuer could depreciate costs over the project's reasonably expected economic life. Costs would be depreciated according to tax rules on depreciation in sections 167 and 168 of the code.

Since issuance costs typically are capitalized as part of the debt and not the project they would fall into the category of expenditures that could not be reimbursed with bond proceeds under the rules.

"As written, the economic life requirement appears inadvertently to prevent an issuer from reimbursing for costs directly associated with the issuance of bonds if they were paid prior to the date the bonds were issued," Mr. Israel told Mr. Walton. However, he said, "few costs are as intimately connected with a bond issue as the costs of issuing that bond, and such costs are not 'working capital' expenditures.

Mr. Israel said it is "appropriate" for issuance costs to be reimbursed with bond proceeds. He proposed amending the rules to say, "costs associated with the issuance of bonds are treated as chargeable to the capital account of property having an economic life of more than one year." And he recommended clarifying that a reimbursement for such costs would be treated as spent when the bonds were issued.

Mr. Walton praised Mr. Israel for his insight and proposed solution. "We're happy to get this kind of comment. It's a very technical question. But it was a very good catch. This is how the comment process should work," he said.

"We most likely will use the fix that Perry has suggested," he added.

Meanwhile, the Internal Revenue Service yesterday issued a notice correcting several typographical errors in the proposed reimbursement rules that were issued in April. The dates in two of the examples given in the proposed rules were changed to correspond with the proposed effective dates of the rules. And the citations of two sections of the tax code involving private activity bonds were corrected.

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