After two sets of proposed regulations, Treasury and IRS have now released final regulations on the definition of “issue price” for purposes of arbitrage investment restrictions that apply to tax-advantaged bonds (the “Final Regulations”) and it appears that the third time’s the charm. Practitioners are particularly praising the addition of a special rule for determining issue price for competitive sales and clarification on determining issue price for private placements.  The Final Regulations were published in the Federal Register on December 9, 2016 and can be found here.

Several years ago, tax regulators became concerned that the longstanding practice of allowing an issue price to be calculated based on reasonable expectations could lead to abuse in that “reasonably expected” issue prices for bonds sometimes differed from the prices at which bonds were actually being sold to retail investors. A determination by the IRS that the “issue price” has been erroneously calculated can have ramifications for the calculation of arbitrage yield that could ultimately cause loss of tax-advantaged status.  A clear and predictable definition of issue price is therefore essential for the tax-advantaged bond community.

After the first set of proposed regulations, published in the Federal Register on September 16, 2013, caused an uproar in the bond counsel community as being largely unworkable, they were withdrawn and re-proposed on June 24, 2015 (the “2015 Proposed Regulations”). The 2015 Proposed Regulations were subject to a comment period followed by a public hearing.  These Final Regulations build on the 2015 Proposed Regulations with certain changes in response to the public comments.

The Final Regulations look to actual facts as the general rule for determining issue price. Generally, the issue price of bonds is the first price at which a substantial amount (at least 10%) of the bonds is sold to the public.  For bonds issued in a private placement to a single buyer, the Final Regulations clarify that the issue price of the bonds is the price paid by that buyer.

In recognition of the need in the tax-advantaged bond community for certainty as of the sale date (particularly in the case of advance refundings), the Final Regulations offer a special rule in the event a substantial amount of bonds has not been sold to the public as of the sale date. The special rule allows reliance on the initial offering price to the public if certain conditions are satisfied including evidence that the bonds were actually offered at the initial offering price and the written agreement of each underwriter that it will not offer or sell the bonds to any person at a price higher than the initial offering price during the period starting on the sale date and ending on the earlier of (i) the close of the 5th business day after the sale date, or (ii) the date on which the underwriters have sold at least 10% of the bonds to the public at a price that is no higher than the initial offering price.

Procedures for satisfying the conditions for use of this special rule will have to be developed but it is reasonable to expect that changes will need to be made to bond purchase agreements and underwriter selling agreements to comply with these requirements.

The special rule for competitive sales provides that in a competitive sale meeting certain requirements, an issuer may treat the reasonably expected initial offering price to the public as of the sale date as the issue price if the winning bidder certifies that its winning bid was based on this reasonably expected initial offering price as of the sale date. This special issue price rule for competitive sales has been repeatedly requested by practitioners and is a welcome improvement over the prior proposed regulations which treated both negotiated sales and competitive sales in the same manner.

The Final Regulations will be effective for obligations that are sold on or after June 7, 2017 and there is no option to rely upon the Final Regulations with respect to obligations that are sold prior to that date. This delayed effective date should allow bond counsel and underwriters time to develop effective and hopefully uniform procedures and documentation to implement the new regulations.

The IRS has announced the procedures, and settlement cost methodology, for issuers seeking to preserve the tax-exemption of those student loan bonds that are at risk of being declared taxable due to the issuer’s attempted compliance with arbitrage restrictions using a loan-swapping technique that the IRS has determined is ineffective.  The closing agreement arrangements, which are only available for bonds not already under audit by the IRS, may require substantial payments from issuers that used loan-swapping and wish to avoid uncertainty as to the tax status of affected bond issues.  Additional detail is provided in our Advisory on this subject.



The much-publicized IRS audit of the Mission Ridge project in Montana has been resolved favorably, with the IRS concluding that the bonds are not “arbitrage bonds” and remain tax-exempt.  The IRS audit had focused on CCRC entrance fees and the technical issue of whether the CCRC erred in not treating its accumulated entrance fees as “replacement proceeds”, which would have required the investment of such funds in a manner that did not produce a yield exceeding the yield on the audited bonds.  On February 8, the IRS Chief Counsel’s office issued a Technical Advice Memorandum (TAM) holding that, although the entrance fees were pledged as collateral for the bonds as part of a general revenue pledge, the bondholders did not have reasonable assurance that the accumulated entrance fees would be available to pay debt service on the bonds in the event that the borrower encountered financial difficulties, and accordingly were not subject to investment restrictions.  This audit has been in the works for over four years and was followed by a number of other audits of similar arrangements around the country. 

The fact that the tax-exemption of these bonds was challenged by the IRS had puzzled many practitioners, issuers and bondholders, as such facts as were known about this CCRC did not suggest that this was anything other than a garden variety revenue pledge.  Moneys that are affirmatively pledged as collateral generally are not considered to be subject to investment restrictions under the arbitrage rules if the borrower can use such funds to pay operating or other expenses without the consent of other parties so that the bondholders cannot count on such amounts being available to pay debt service – this is what bond counsel sometimes refer to as a “defeatable pledge.”

A TAM is like a private letter ruling, except that it arises in the context of an audit, not before.  This TAM will resolve this audit.  Will the IRS now retreat in the other pending cases?  Perhaps not.  These cases are inherently fact-specific.  Here the IRS audit staff made numerous arguments based on the documents as well as accounting principles, all of which seem to have been rejected by the Chief Counsel’s office.  However, a different deal will have different documents and restrictions.  In addition, an important factor here was that the borrower in fact was using a substantial amount of the accumulated funds to pay operating expenses.  In other cases it may be less clear that the borrower is not relying upon the accumulated entrance fees to pay debt service.  How much accumulation is too much accumulation?  That could be the battleground in future cases. 

While this audit was about entrance fees, the final paragraph of the TAM, in which the favorable conclusion is delivered, refers to a nexus between “the entrance fees (and other revenues) and the Bonds” (emphasis added), thereby making clear that this issue is presented by every revenue pledge, not just entrance fees in a CCRC deal.