Rebate and yield reduction: Required payment dates for interim computation dates

 

This issue snapshot discusses 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.

IRC Section and Treas. Regulation

IRC Section 148(f) -- Required rebate to the United States

Regulations Section 1.148-3 -- General Arbitrage Rebate Rules

Regulations Section 1.148-4 -- Yield on an Issue of Bonds

Regulations Section 1.148-5(c) -- Yield reduction payments to the United States

Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources)

Rev. Proc. 2005-40, 2005-2 C.B. 83, provides guidance on penalties and interest to be paid so that a late rebate payment does not result in bonds being arbitrage bonds.

Analysis

IRC Section 148(f) provides, in part, that a bond is an arbitrage bond if it is part of an issue that fails to meet the requirement to pay rebate in installments at least once every five years. Treas. Reg. Section 1.148-3(h) provides that the failure to pay the correct rebate amount when required will cause the bonds of the issue to be arbitrage bonds, unless the Commissioner determines that the failure was not caused by willful neglect and the issuer promptly pays a penalty and interest on the late payment to the United States. In certain circumstances, issuers can make yield reduction payments. Yield reduction payments are to be paid in the same time and manner as the payment of rebate amounts. Treas. Reg. Section 1.148-5(c).

The first rebate installment payment must be made for a computation date that is not later than five years after the issue date (the "first required payment 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. Treas. Reg. Section 1.148-3(f)(1). Treas. Reg. Section 1.148-3(e)(2) describes the final computation date for which the rebate amount must be paid with respect to an issue.

A "computation date" is each date on which the issuer computes the rebate amount under Treas. Reg. Section 1.148-3(e). Issuers of a fixed yield issue may treat any date as a computation date. For a variable yield issue, an issuer may treat the last day of any bond year ending on or before the first required payment date as a computation date, but the issuer may not change that treatment after the first payment date. After the first required payment date, the issuer must consistently treat either the end of each bond year or the end of each fifth bond year as computation dates and may not change these computation dates after the first required payment date. A "bond year" is each one-year period that ends on the day selected by the issuer, and the first and last bond years may be short periods. If the issuer does not select a bond year before the earlier of the final maturity date of the issue or the date that is five years after the issue date, bond years end on each anniversary of the issue date and on the final maturity date.  Treas. Reg. Section 1.148-1(b).

The yield on a variable yield issue is computed separately for each computation period. Treas. Reg. Section 1.148-4(c)(1). A "computation period" is the period between computation dates. The first computation period begins on the issue date and ends on the first computation date. Each succeeding computation period begins on the date immediately following the computation date and ends on the next computation date. The bond yield for the computation period is the specific discount rate that produces a present value for the discounted payment amounts that is equal to the aggregate issue price (or deemed issue price, as described below in this paragraph) of the bonds of the issue as of the first day of the computation period. The discount rate is applied to all the payments of principal and interest and fees for qualified guarantees on the bonds that are attributable to the computation period. For bonds outstanding on the last day of a computation period, a deemed payment equal to value of the outstanding bonds is included for that day. For computation periods after the first period, the deemed issue price as of the first day of the computation period is the same as the deemed payment equal to the value of the bonds on the last day of the previous computation period.

Each rebate payment must be paid not later than 60 days after the computation date to which the payment relates. Treas. Reg. Section 1.148-3(g). An issuer may use more than one computation date in computing the rebate amount for a period. When an issuer uses more than one computation date in a period for which a rebate payment is made, the rebate payment "relates" to the latest computation date the issuer uses for the period. Thus, a payment is not required within 60 days of each "interim computation date" (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, is not later than five years after the previous computation date for which an installment payment was made. Further, if the issuer uses an interim computation date, and does not make an installment payment with respect to that interim computation date, it must properly future value the unpaid rebate amount to the next interim computation date, or the latest permissible computation date for the computation period, as the case may be, and include that future value amount when it computes the rebate amount as of that next computation date.

Issue indicators or audit tips

Generally, issuers of a variable yield issue use interim computation dates in addition to the latest permissible computation dates in order 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.

An issuer of a variable yield issue must use permitted computation dates in computing rebate. Each computation date, including interim computation dates, must be the end of a bond year, and after the first required payment date, must be either the end of every bond year or the end of every fifth bond year.