ARBITRAGE REBATE COMPLIANCE
Submitted by Dave Frederick, Partner

Arbitrage rebate compliance has challenged issuers of tax-exempt debt since 1986. With the passing of the Tax Reform Act of 1986, the Federal Government sought to limit the amount of investment income earned on unspent proceeds of tax-exempt financings. The excess earnings, called arbitrage, result from the ability to obtain tax-exempt bond proceeds and invest the funds in higher yielding taxable securities, resulting in a profit.

The Arbitrage rebate requirements apply to virtually all issuers of tax-exempt financings including municipalities, airport and transportation, healthcare, higher education, water and wastewater, housing, sport facilities, convention centers and school districts.

However, there is a small-issuer exception from rebate for any issuer of governmental bonds by a municipality that does not issue more than $5 million of governmental bonds in a calendar year. An additional annual exemption amount under the small-issuer rebate exemption may apply to issuers of bonds to finance construction of public school facilities. If those guidelines are met, the small-issuer exemption for public school related financings increases from $5 million to $15 million.

Generally, a rebate computation and payment to the Federal Government (if necessary) must be made at least every five years (the Rebate Installment Computation Date) and upon final redemption or maturity of the bond (the Final Rebate Computation Date). Payments are due to the Federal Government within 60 days of either the Rebate Installment Computation Date or the Final Rebate Computation Date.

The Internal Revenue Code and Department of Treasury Regulations provide various exceptions to arbitrage rebate for which an issuer may qualify. As well, elections can be made by an issuer, which may have an impact on the arbitrage rebate calculation and the timing of payments due to the Federal Government.

Arbitrage rebate compliance continues to be a major concern for tax-exempt issuers as the rules are complex and can be confusing. Failing to understand and follow complex arbitrage rebate rules may produce adverse consequences to the tax-exempt issuer. The issuer may be required to pay substantial penalties to the Internal Revenue Service or, worse yet, the issuer may face having its financings lose their tax-exempt status.

For further information or assistance with arbitrage, please contact us at footnotes@umbaugh.com.