Summary

On June 24, 2015, the Treasury Department and the Internal Revenue Service (IRS) proposed new rules regarding the definition of issue price for tax-exempt bonds contained in IRS Regulation Section 1.148-1(b) under the Internal Revenue Code of 1986, as amended (the Code) (the 2015 Proposed Regulations), and withdrew proposed changes to these rules it had released in 2013.

Current Rule

Under current IRS regulations, the issue price of tax-exempt bonds that are publicly offered generally is the first price at which a substantial amount (defined as 10 percent) of the bonds is sold to the public.

  • The public does not include bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters or wholesalers.
  • The issue price does not change if part of the issue is later sold at a different price.
  • The issue price of bonds that are not substantially identical is determined separately (i.e., separate maturities of an issue are treated separately).
  • The issue price of bonds for which a bona fide public offering is made is determined as of the sale date based on the underwriter's reasonable expectations regarding the initial public offering price.
  • The issue price of bonds may not exceed their fair market value as of the sale date.

2015 Proposed Regulations

General Rule — Actual Sales of At Least 10 percent. Under the 2015 Proposed Regulations, the issue price of bonds will generally be the first price at which a substantial amount of the bonds is sold to the public. As under the current regulations, the issue price of bonds that do not have the same credit and payment terms (for example, separate maturities of an issue) is still determined separately.

Definition of Substantial Amount. As under the current regulations, 10 percent remains a substantial amount.

Definition of Public. The 2015 Proposed Regulations expand the definition of the "public."

  • "Public" means any person other than an underwriter or a related party to an underwriter.
  • "Underwriter" includes:
  1. Any person that contractually agrees to participate in the initial sale of the bonds to the public by entering into a contract with the issuer (or with the lead underwriter to form an underwriting syndicate); and
  2. Any person that, on or before the sale date, directly or indirectly enters into a contract or other arrangement with such a person to sell the bonds.

Therefore, bonds sold to a broker, dealer, or bond house which is not part of the underwriting syndicate (and which does not have a contractual relationship with the issuer or any member of the underwriting syndicate) would qualify as sales to the public and count toward the 10 percent threshold.

Alternative Safe-Harbor Method Using Initial Offering Price Where Less Than 10 percent Sold. Under the 2015 Proposed Regulations, if less than 10 percent of bonds are sold on or before the sale date, the issuer may use an alternative safe harbor method for determining issue price based on the initial offering prices for the bonds. Since the determination is made on a maturity-by-maturity basis, there may be instances where the alternative method must be used for certain maturities of a single bond issue, while the general rule can be used for other maturities.

Requirements. In order to use the alternative method, all of the following requirements must be met:

  1. All orders placed by the public and received by the underwriters on or before the sale date must be filled at the initial offering price (unless the order exceeds the principal amount of the bonds to be sold).
  2. The underwriters must not fill any order received by the underwriters on or before the sale date at a price higher than the initial offering price.
  3. The issuer must obtain certifications from the sole or lead underwriter of the following:
    1. The initial offering price;
    2. That the underwriters met the requirements of paragraph (A) and (B) above; and
    3. That no underwriter will fill an order received from the public after the sale date and before the issue date at a price higher than the initial offering price, except if the higher price is the result of a market change (such as a decline in interest rates) for those bonds after the sale date.
  4. The issuer must not know or have reason to know, after exercising due diligence, that the certifications described above are false.

Supporting Documentation. Under both the general rule and the alternative method, the issuer will be required to maintain documentation to support the issue price determinations. Under the general rule, the issuer must include in its books and records documentation of the issue price, which could consist of a certification from the underwriter regarding the issue price and reasonable supporting documentation for this price.

However, the alternative method will require a higher level of diligence and documentation, in that the issuer will also have a due diligence obligation to review the certifications and supporting documentation provided by the underwriter to meet the requirements of the rule. The 2015 Proposed Regulations indicate that a copy of the pricing wire (or equivalent communication) would be acceptable supporting documentation for the initial offering price. The 2015 Proposed Regulations indicate that for bonds sold at a price higher than the initial offering price between sale and closing, required supporting documentation will include both the pricing information (amounts, prices and sale dates) and information regarding corresponding market changes, such as "proof of the values of a broad-based index of municipal bond interest rates on bonds similar to the type and credit rating of the bonds being sold" to support use of the alternate method.

Other Changes From Current Regulations

Other changes to note from the current regulations are that the 2015 Proposed Regulations would no longer provide for determination of issue price based upon reasonable expectations, and therefore no longer retain the concept of a bona fide public offering. In addition, determination of the fair market value of bonds on the sale date is no longer required.

Effective Date

If adopted, the 2015 Proposed Regulations will apply prospectively to bonds that are sold on or after the date that is 90 days after publication of the final regulations in the Federal Register. In addition, the preamble to the 2015 Proposed Regulations states that issuers may at their option elect to apply the 2015 Proposed Regulations with respect to bonds that are sold on or after June 24, 2015.

The IRS is accepting comments on the 2015 Proposed Regulations until September 22, 2015. A public hearing is scheduled for October 28, 2015.

For more information, the full text of the 2015 Proposed Regulations can be found at here.