4.82.1  Examining Qualified Small Issue Bonds  (01-01-2003)
Qualified Small Issue Bonds

  1. This section provides procedures for examining qualified small issue bonds under section 144(a) of the Internal Revenue Code. At the start of the examination, the examiner should:

    1. Determine if the Issuer is a qualified issuer; and

    2. Determine if the issue is a refunding or new money issue.  (01-01-2003)
New Money Bonds

  1. Determine if the facilities are qualified facilities to be financed with qualified small issue tax-exempt bonds.

  2. Determine whether 95% of the proceeds of the issue were used for the project or refunding.

  3. Determine the facilities financed with the issue.

  4. Determine the principal user(s) of the facility.

  5. Identify any related parties of the principal user(s).

  6. Identify any other bond financed facilities of the principal user(s) or related parties in the same incorporated municipality or same county.

  7. Determine whether the type of bonds used to finance the other facilities were qualified small issue bonds, exempt facility bonds, qualified redevelopment bonds or industrial development bonds (IDBs) issued under the 1954 Code to which IRC 141(a) does not apply.  (01-01-2003)
Size Limitations

  1. The following procedures should be taken into account when determining if the size limitations have been exceeded.  (01-01-2003)
$1,000,000 Limitation

  1. Determine the aggregate of the face amount of the issue under examination and the face amount of the outstanding prior qualified small issues used to finance facilities located within the same incorporated municipality or county, and which have the same principal users (or a related party) as the facility financed with the issue under examination.  (01-01-2003)
$10,000,000 Limitation

  1. Determine if a proper election was made to substitute $10,000,000 for the $1,000,000 limitation. See section 1.103–10(b)(2)(vi) of the Income Tax Regulations.

  2. Determine whether the aggregate face amount of the issue exceeds $10,000,000 by adding to the amount determined above the aggregate amount of capital expenditures with respect to the facilities located within the same incorporated municipality or county that were paid or incurred during the 6-year period beginning 3 years before the date of issue and ending 3 years thereafter.

  3. Determine whether any of the capital expenditures on any facility financed with the net proceeds of the issue also benefited from an Urban Development Grant (UDAG). If so, ignore up to $10,000,000 of capital expenditures for purposes of this limitation.  (01-01-2003)
$40,000,000 Limitation

  1. Determine the test period beneficiaries of the financed facility during the 3-year period beginning the later of when the facilities were placed in service or when the bonds were issued.

  2. Determine whether the test period beneficiaries were owners or users of other facilities in any state financed with exempt facility related bonds (exempt facility bonds, qualified small issue bonds, qualified redevelopment bonds under IRC 142 and 145 and IDBs issued under the 1954 Code to which IRC 141(a) does not apply).

  3. Determine whether any of the tax-exempt facility related bonds were outstanding at the time of the issuance of the issue.

  4. Determine the aggregate face amount of the outstanding tax-exempt facility related bonds allocated to a test period beneficiary by finding the proportionate amount of the outstanding tax exempt facility related bonds allocated to each test period beneficiary.

  5. Determine whether the aggregate face amount of the issue plus the aggregate face amount of the facility related bonds allocated to a test period beneficiary exceeds $40,000,000.  (01-01-2003)

  1. Determine if net proceeds were used to redeem part or all of a prior issue which was used for the acquisition, construction, reconstruction of land or depreciable property.

  2. Determine whether the net proceeds of refunding bonds were used to redeem refunded bonds not later than 90 days after the date of the issuance.

  3. Determine if the average maturity date of the refunding bonds is no later than the average maturity date of the refunded bonds.

  4. Determine if the amount of the refunding bonds is greater than the outstanding amount of refunded bonds.  (01-01-2003)

  1. Determine if the average maturity of the bonds exceeds 120% of the average reasonably expected economic life of the facilities being financed with the net proceeds. IRC 147(b).  (01-01-2003)
Discrepancy Adjustments

  1. Determine if the straight line depreciation method was used for assets purchased with tax exempt bond proceeds.  (01-01-2003)
Examination Guidelines

  1. This section provides guidance when an examiner encounters an arbitrage issue in an examination.

  2. Under IRC 103, the interest on an arbitrage bond is included in gross income. A bond is an arbitrage bond if it does not meet the yield restriction requirements of IRC 148(a) or the rebate requirements of IRC 148(f). IRC 148(a) provides that, with certain exceptions, each bond in an issue is an arbitrage bond if the yield on invested proceeds of the issue is reasonably expected on the issue date to be materially higher than the yield on the issue or the issuer intentionally uses those proceeds to earn a materially higher yield. Under IRC 148(f), even if the issue meets the yield restriction rules, an issuer may be required to rebate to the United States any arbitrage earned on nonpurpose investments allocated to gross proceeds of the issue. If the issuer fails to pay the required rebate, the bonds are arbitrage bonds.  (01-01-2003)

  1. Determine which regulations apply under IRC 148.

  2. Check the accuracy of the issuer's calculation of yield on the issue by determining the following:

    1. Whether the bonds are outstanding;

    2. The issue date and purchase price of the bonds;

    3. Payment schedule for the bonds;

    4. Redemption price at maturity;

    5. Final maturity date;

    6. Whether the bond is subject to early redemption;

    7. Whether there is a credit enhancement that is a qualified guarantee;

    8. The existence of hedges;

    9. Whether the issuer has transferred, modified, or similarly waived any right attached to the bond;

    10. Whether issuer has used consistent accounting conventions; and

    11. Check for accuracy of present value computations.  (01-01-2003)
Computing Rebate

  1. Compute rebate under the future value method by obtaining the following:

    1. Identify nonpurpose investments (defined under section 1.148–1(b) of the regulations) allocated to the issue;

    2. Construct a schedule showing the amount of dates of payments and receipts with respect to the nonpurpose investments. Show payments as negative amounts, receipts as positive amounts. Create another column showing the future value of each payment and receipt as of the rebate computation date. The sum of the future value amounts is the rebate amount;

    3. Obtain copies of the Issuer's Form 8038–T(s);

    4. Examine the issuer's books and records to locate any elections made by the issue; and

    5. Determine whether rebate computation dates should be accelerated. Contact the Field Operations Manager before sending notice of demand for payment and consider obtaining assistance from Area Counsel.

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