Under the arbitrage rebate and yield limitation regulations, interim payment of excess earnings above the Bond Yield are required to be paid to the United States Treasury within sixty days of each five-year anniversary date and after the final redemption.
That is, any interest earnings on bond proceeds invested above the bond yield will have to be “rebated” to the United States government.
CHEFA will monitor your issue’s arbitrage rebate status and prepare any arbitrage rebate filings as they may occur. CHEFA staff is available to answer any questions you have on this difficult subject.
Arbitrage Rebate is a tax of the profit earned from arbitrage that must be rebated 100% to the Federal Government. Click image to enlarge in new window.
In most cases, the only funds that are subject to arbitrage rebate are the Cost of Issuance Account, Construction Fund, Capitalized Interest Account and/or the Debt Service Reserve Fund. (In some cases, other funds may be subject to rebate, as well.)
If any of these accounts are invested with a yield higher than the bond yield there is a chance for arbitrage. But the rate of return on each of these accounts can be blended together, often times resulting in no liability at all.
Rebate liability can be generated if all of the bond proceeds together earn a net investment yield above the bond yield.
The IRS allows unlimited earnings on Construction Bond Proceeds if a spending schedule is followed.
If all the Spending Rules are met:
If the construction proceeds are invested above the bond yield and the spending requirements are met, these earnings can be excluded from the calculation of arbitrage rebate. Therefore all the earnings can be used for the project.
If all the Spending Rules are not met:
If all the spending requirements are not met, the fund is subject to arbitrage rebate. The account will be analyzed to determine if the investment yield was greater than the bond yield. This calculation will be merged with the earnings on the other funds. If the net investment earnings are still above the bond yield then arbitrage rebate is due.
The amount of arbitrage rebate due is only the portion of earnings above the bond yield.
The arbitrage rebate liability is never the original amount deposited into the account. It is only a portion of the interest earned.
The IRS intended this Spending Exception to encourage institutions to spend the bond proceeds quickly. It was not intended to penalize institutions for not spending quickly enough.
Even if the spending schedule is not followed, the only way a rebate liability can be generated is if the funds are invested above the bond yield. Even then the liability can only be a portion of the interest earned on an account.