Everyone knows that investment and capital finance rates have increased dramatically in the last 15 months. There are many opinions as to when those rates will cease their upward trends, but one thing is certain – arbitrage rebate liabilities are back and suddenly what was OLD is NEW again! We wanted to share some of the questions we are receiving.

What is Arbitrage?

Under the U.S. Treasury Regulations issuers of tax-exempt bonds may not earn investment interest on bond proceeds (the “Taxable Rate”) that is in excess of the interest paid to the bondholders (the “Tax-Exempt Rate”). The difference in these rate spreads is called “arbitrage” and any arbitrage accrued must be paid to the Internal Revenue Service in the form of an arbitrage rebate payment.

How often is an arbitrage rebate calculation required?

Bond issues are due for compliance no later than the 5th anniversary of the bonds’ issuance date, and every 5th year thereafter. Even if your issue does not earn arbitrage, the calculation is required at least every five years as long as the issue is outstanding to provide proof to auditors that the issuer is compliant with the Internal Revenue Service’s requirements.  We strongly recommend annual compliance reviews, if at all possible, to maximize the issuer’s efficiency and minimize the financial and time impacts of staff and document retrieval.

Arbitrage Rebate AND Yield Restriction?

The IRS provides a “Temporary Period” for Capital Projects of three years to spend those proceeds. Once the temporary period ends, project proceeds are “yield restricted” to the bond yield + .125%. If the interest earned on those proceeds is yielding above the allowable amount, a yield reduction payment is due. As long as project proceeds remain unspent after 3 years, the issuer is required to make both calculations. Even if you qualify for a Small Issuer Exception, yield restriction STILL applies.

Are there any exceptions to a full calculation?

Yes! If you qualify as a Small Issuer – you are exempt from a full calculation for arbitrage rebate. However, you are not exempt from yield restriction rules. If you qualify as a Small Issuer, BUT your capital project proceeds remain outstanding beyond the Three-Year Temporary Period, you are required to have a yield reduction calculation completed.

Who qualifies for the Small Issuer Exception?

If a government entity with general taxing power, or a subordinate entity, issues $5 million or less in cumulative tax-exempt financings in one calendar year, they are exempt from the arbitrage rebate requirements. The Small Issuer Exception limits are increased to $15 million when at least $10 million is used to finance public schools. Please note, yield restriction rules still apply to Small Issuers.

What if all my proceeds have been spent in two years or less?

If you meet a spending exception, you do not need the calculation, and if you have earned arbitrage earnings, you get to keep those excess earnings. The spending exceptions are:

    • 6 Month Exception
      Spending 100% at 6 Months
    • 18-Month Exception
      Spend 15% at 6 Months
      Spend 60% at 12 Months
      Spend 100% at 18 Months (5% reasonable retainage)
    • 2-Year Construction Exception
      Spend 10% at 6 Months
      Spend 45% at 12 Months
      Spend 75% at 18 Months
      Spend 100% at 24 Months (5% reasonable retainage)

Keep in mind that to qualify for the spending exception, each of the benchmarks must be met. Missing even one benchmark eliminates your exception and a full arbitrage rebate calculation is required.

My negative liability is becoming a positive arbitrage liability. Does that mean I will have to pay?!

Many issuers have become accustomed to seeing a negative arbitrage liability in their annual and installment calculations. The economy has changed dramatically over the last several years – and many issuers are now seeing their previous negative liabilities eroding to zero and/or turning positive. That means arbitrage earnings are now outpacing the allowed yield of return. Does that mean you will have to make a payment to the IRS? MAYBE! More importantly, it means your potential liability needs to be managed.

I’ll keep all my gross proceeds in a non-interest-bearing account so I won’t have to pay!

As a finance professional, that is certainly your option. However, not earning ANY investment earnings means your entity is losing out on that portion you CAN retain. AND if you meet a spending exception, the entity is allowed to retain ALL the interest earned on the debt proceeds. Consider that as a reward for planning and spending well! Arbitrage rebate compliance is not optional – it is required. If no interest is earned, that decision has actually cost your entity resources that could be used for other budgeted needs.

Can Bingham help me determine my potential rebate liability?

We would be honored to assist your entity prepare an evaluation for potential arbitrage rebate liabilities. Bond issuers large and small trust Bingham with their arbitrage rebate calculations. Our firm has performed calculations for a combined estimated $140 Billion in bond proceeds and has more than 1,500 active clients. Since 1988, we’ve handled issues valued from $150,000 to over $1 Billion for organizations including public utilities, municipalities, counties, states, public authorities, universities, public and charter school districts, airports, public-private partnerships (P3), retirement communities, and private issuers. Our account managers have compiled over 80 years of experience, bringing value, consistency, and individualized service to our clients. Consequently, Bingham has the specific knowledge and experience needed to ensure regulatory compliance and precision reporting for every client. We offer quick turnaround and highly attentive service.

Still have questions? Bingham has answers!

The more you understand about your rebate calculation, the better. Don’t hesitate to call a Bingham professional at (804) 288-5312 or send an email to [email protected] to open a line of conversation for answers.

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