Are There Ways to Keep Arbitrage?

There are two wide-ranging statutory exceptions allowable under the arbitrage rebate regulations that exempt an issue from the arbitrage rebate requirements.  These exceptions are known as the Small Issuer Exceptions to Rebate and the Spending Exceptions to Rebate.

Small Issuer Exceptions to Rebate

The procedures listed below are designed to assist an issuer in determining if a tax-exempt debt issue meets the Small Issuer Exception to the arbitrage rebate requirements.  Please note that although the debt issue may meet the Small Issuer Exception to Rebate, it may still be subject to the yield restriction requirements:

$5M Small Issuer Exception:

  • Issuer has general taxing powers (does not apply to private activity, 501(c)(3), or student loan debt).
  • Debt issue is governmental.
  • At least 95% of the proceeds are to be used for local governmental activities of the issuer or by governmental units located within the issuer's boundaries.
  • Debt issues' face amount is less than $5,000,000 (par value may be used unless the debt is issued at a premium which exceeds 2% of par, in which case, use the issue price).
  • Total of tax-exempt debt issued in the calendar year is less than $5,000,000.
  • Additional Requirements to meet the Small Issuer Exception for a Refunding Debt Issue:
    • The weighted average maturity of the refunding debt issue (new bond) is less than the weighted average maturity of the refunded debt issue (old bond).
    • The final maturity date of the refunding debt issue is less than 30 years from the original issue date of the refunded bond.
    • Debt being refunded (old bond) qualified for the Small Issuer Exception.

Note - Historically 1/3 of refunding bonds (new debt) fail one of the three rules listed above and are therefore subject to the arbitrage rebate regulations.

The IRS Regulations allow for additional exceptions to the arbitrage rebate requirements for public school capital expenditures:

Public School - Small Issuer Exceptions:

  • $5M for Tax-Exempt Debt (issued from 8/86 - 12/31/97)
  • $10M for Tax-Exempt Debt (issued from 1/1/98 - 12/31/01)
    • $5M can be used for any purpose. The amount that exceeds $5M must be for new public school construction.
  • $15M for Tax-Exempt Debt (issued from 1/1/02 - current)
    • $5M can be used for any purpose. The amount that exceeds $5M must be for new public school construction.

Spending Exceptions to Rebate

There are three possible Spending Exceptions listed below:

6-Month Spending Exception:

If all gross proceeds and interest earnings of the issue are expended within 6 months after the date of issuance of the debt, the interest earned during that period is not subject to rebate.

The Reserve Fund and Debt Service Fund are subject to the arbitrage rebate requirements and do not qualify for exemption through the 6-Month Spending Exception.

18-Month Spending Exception:

If all gross proceeds and expected earnings are spent within and according to a strict 18 month timetable, the interest earned during that period is not subject to rebate. Intermediate expenditure requirements are necessary:

  • 15% within 6 months
  • 60% within 12 months
  • 100% within 18 months

The Reserve Fund and Debt Service Fund are subject to the arbitrage rebate requirements and do not qualify for the exemption under the 18-Month Spending Exception.

2-Year Spending Exception:

If an issue qualifies as a “construction issue” (75% of issue is actually spent on construction) and all gross proceeds and expected earnings are spent within and according to a strict 2 year timetable, the interest earned during that period is not subject to rebate. Intermediate expenditure requirements are necessary:

  • 10% within 6 months
  • 45% within 12 months
  • 75% within 18 months
  • 100% within 2 years

The Reserve Fund is subject to the arbitrage rebate requirements for the entire period unless an election is made to include interest earnings in the 2-Year Spending Exception (during the construction period).  The Debt Service Fund is subject to the arbitrage rebate requirements and do not qualify for the exemption under the 2-Year Spending Exception.