TEMPORARY REGULATIONS EXPLAIN YIELD ADJUSTMENT PAYMENTS FOR EXCESS EARNINGS ON QUALIFIED STUDENT LOAN BONDS.

SUMMARY:

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to certain yield adjustment payments to be made with respect to excess earnings on acquired purpose obligations acquired with proceeds of qualified student loan bonds. Changes to the applicable law were made by the Tax Reform Act of 1984 and the Tax Reform Act of 1986. The text of the temporary regulations set forth in this document also serves as the text of the proposed regulations cross- referenced in the notice of proposed rulemaking in the proposed rules section of this issue of the Federal Register.

EFFECTIVE DATE: These temporary regulations are effective for qualified student loan bonds issued after January 5, 1990.

FOR FURTHER INFORMATION CONTACT: George F. Delduke, 202-566-4545 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On July 5, 1989, proposed amendments to the Income Tax Regulations (26 CFR Part 1) under section 148 of the Internal Revenue Code, relating to arbitrage bonds, were published in the Federal Register (54 FR 28075). Section 1.148-10(b)(2)(ii) of the proposed regulations states that the Commissioner shall adopt procedures under which issuers of qualified student loan bonds described in section 144(b)(1)(A) may "rebate" to the United States amounts necessary to reduce the yield on student loans to a yield that is not materially higher than the yield on the issue. A public hearing with respect to the proposed regulations was held on December 13, 1989. Most of the provisions of the proposed regulations are being adopted in T.D. 8284 in the rules and regulations portion of this issue of the Federal Register.

Numerous commentators at the public hearing as well as those submitting written comments regarding the proposed regulations have expressed concern that the absence of guidance regarding the implementation of the "rebate" procedure described in section 1.148- 10(b)(2)(ii) was a significant problem. These temporary regulations provide guidance regarding the "rebate" procedure referred to in section 1.148-10(b)(2)(ii) of the proposed regulations. Because of the possibility of confusion with the "rebate" referred to in section 148(f), the "rebate" payment referred to in section 1.148- 10(b)(2)(ii) of the proposed regulations is renamed a "yield adjustment payment" in these temporary regulations.

EXPLANATION OF PROVISIONS

Issuers of qualified student loan bonds must restrict the yield to maturity (yield) on acquired purpose obligations (student loan notes) acquired with proceeds of the bonds to a yield that is not materially higher than the yield on the bonds. Because of factors such as variable administrative costs and variable special assistance payments (SAP), the yield on the student loan notes may be materially higher than the yield on the bond issue. Under the temporary regulations, qualified student loan bonds that would be arbitrage bonds solely because the yield on student loan notes acquired with proceeds of the bonds is materially higher than the yield on the bond issue are not arbitrage bonds if the issuer makes yield adjustment payments to the United States based on the amount of excess earnings on the student loan notes. Excess earnings on student loan notes are that portion of the total earnings taken into account in determining the yield on the notes which results in the notes having a materially higher yield than the bond issue.

The payment of yield adjustment payments to the United States does not prevent a qualified student loan bond from being an arbitrage bond if proceeds of the bond not invested in student loan notes are invested in a manner that would cause the bonds to be arbitrage bonds under section 148. The temporary regulations apply only to student loan notes.

Generally, the temporary regulations require the issuer to calculate excess earnings on or before the tenth anniversary of the date of issue of the bond issue and every five years thereafter (the excess earnings calculation date). The temporary regulations also require that excess earnings be calculated on the date the last bond that is part of an issue matures or is redeemed. Yield adjustment payments are based on excess earnings end are due on or before the date that is 60 days after the excess earnings calculation date.

A problem may arise in calculating excess earnings and making yield adjustment payments prior to the final maturity or redemption of a bond issue because the issuer may not yet know of all the amounts that will eventually be taken into account in computing the yield on either the bonds or the student loan notes. Servicing fees and other costs of administering a student loan program tend to be relatively constant over the life of a student loan while interest earnings and SAP with respect to a student loan generally decline over the life of the loan. Therefore, computation of the yield on a student loan note prior to the date it matures or is redeemed may result in a higher yield (and therefore a higher excess earnings amount) than would be computed at maturity. Most student loan notes mature or are repaid within 7 years of the date repayment of the loan begins (usually 8 to 11 years after the loan is made). The temporary regulations generally do not require an excess earnings calculation and a corresponding yield adjustment payment until 10 years after the date of issue of the bonds. Also, the temporary regulations generally require that only 50 percent of excess earnings be paid in the first yield adjustment payment (60 days after the tenth anniversary) and only 75 percent of excess earnings be paid in subsequent yield adjustment payments prior to maturity or redemption of the bonds. One hundred percent of excess earnings is due upon maturity or redemption of the last bond that is part of the issue.

Requiring less than 100 percent of excess earnings to be paid in yield adjustment payments other than at maturity or redemption provides a "cushion" in the event that subsequent earnings and expenses allocable to the notes cause a previously computed yield to be too high. This "cushion" should also significantly reduce any possibility of an overpayment of excess earnings to the United States.

The Service welcomes comments regarding the computation of excess earnings, the yield adjustment payment amount, and yield adjustment payment intervals.

EFFECTIVE DATE

These temporary regulations apply to qualified student loan bonds issued after January 5, 1990.

SPECIAL ANALYSES

It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

The principal author of these regulations is David A. Walton, Office of the Assistant Chief Counsel (Financial Institutions and Products), Internal Revenue Service. However, other personnel from the Service and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR 1.61-1.281-4

Income taxes, Taxable Income, Deductions, Exemptions.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR Part 1 is amended as follows:

PART 1 -- [AMENDED]

Paragraph 1. The authority for Part 1 is amended by adding the following citation:

Authority: 26 U.S.C. 7805. * * * Section 1.148-10T also issued under 26 U.S.C. 148(g) and (i) and 98 Stat. 924.

Par. 2. The following new section 1.148-10T is added in the appropriate place:

SECTION 1.148-10T SPECIAL RULES FOR QUALIFIED STUDENT LOAN BOND PURPOSE INVESTMENTS (TEMPORARY).

(a) YIELD ADJUSTMENT PAYMENT OF EXCESS EARNINGS TO THE UNITED STATES -- (1) EFFECT OF YIELD ADJUSTMENT PAYMENTS. If an issuer of qualified student loan bonds, at the time and in the manner prescribed in paragraph (d) of this section, remits to the United States yield adjustment payments as described in paragraph (e) of this section, then, for purposes of determining whether the bonds are arbitrage bonds, the yield of the class of acquired purpose obligations (student loan notes) that were acquired with the proceeds of the bonds is deemed to be not materially higher than the yield on the bond issue. For purposes of computing the yield under section 148 on the class of acquired purpose obligations, yield adjustment payments that are so remitted are treated as reductions in the earnings of the class of obligations.

(2) SCOPE OF SECTION. This section applies only to qualified student loan bonds and to acquired purpose obligations of a qualified student loan bond issue that are eligible to be treated as acquired program obligations under section 1.103-13(h).

(b) EXCESS EARNINGS DEFINED -- (1) IN GENERAL. As of any excess earnings calculation date (defined in paragraph (c) of this section), the excess earnings of the class of acquired purpose obligations is the smallest amount that, if treated as reasonable costs (taken into account in calculating yield) paid on that date, would reduce the yield on the class to a yield that is not materially higher than the yield on the bonds. See sections 1.103-13(b)(5)(viii), 1.103- 13(b)(5)(ix), and 1.148-10(b)(1).

(2) YIELD DEFINED. For purposes of this paragraph (b), as of any excess earnings calculation date, the yield on the class of acquired purpose obligations and the yield on qualified student loan bonds is computed in the manner set forth in section 1.103-13(c) with the following modifications --

(i) The calculation of excess earnings is cumulative, and each prior yield adjustment payment is taken into account (as of the excess earnings calculation date with respect to which the payment was calculated) as a reduction in the earnings on the class of acquired purpose obligations;

(ii) Obligations acquired after the excess earnings calculation date are not taken into account in determining the yield on the obligations;

(iii) Acquired purpose obligations held on the excess earnings calculation date are treated as if liquidated on that date at their stated redemption price at maturity plus unpaid accrued interest as of the excess earnings calculation date;

(iv) If the issue price of a bond was at least 98 percent of its stated redemption price at maturity and the bond is outstanding as of the excess earnings calculation date --

(A) All interest and principal payments due with respect to the bond between the excess earnings calculation date and the deemed redemption date are treated as paid as of the dates due, and

(B) The bond is treated as redeemed as of the deemed redemption date at an amount equal to the stated redemption price of the bond at maturity plus interest (other than original issue discount, if any) scheduled to be accrued and unpaid as of the deemed redemption date less any payments of principal paid on or before the excess earnings calculation date and less any payments of principal described in paragraph (b)(2)(iv)(A) of this section;

(v) If the issue price of a bond was less than 98 percent of its stated redemption price at maturity and the bond is outstanding as of an excess earnings calculation date --

(A) All interest and principal payments due with respect to the bond between the excess earnings calculation date and the deemed redemption date are treated as paid as of the dates due, and

(B) The bond is treated as redeemed as of the deemed redemption date at an amount equal to the issue price plus interest (including original issue discount) scheduled to be accrued and unpaid as of the deemed redemption date less any payments of principal paid on or before the excess earnings calculation date and less principal payments described in paragraph (b)(2)(v)(A) of this section; and

(vi) The accrual of original issue discount is determined in the manner provided by section 1272(a).

(c) EXCESS EARNINGS CALCULATION DATE DEFINED -- (1) FIRST EARNINGS CALCULATION DATE. The first excess earnings calculation date with respect to an issue is a date chosen by the issuer that is no later than the earlier of --

(i) The date the last bond that is part of the issue matures or is redeemed, or

(ii) The tenth anniversary of the date of issue of the bond issue.

(2) SUBSEQUENT EXCESS EARNINGS CALCULATION DATES.

Subsequent to the first excess earnings calculation date, each excess earnings calculation date is the earlier of --

(i) The date that is 5 years after the immediately preceding excess earnings calculation date, or

(ii) The date the last bond that is part of the issue matures or is redeemed.

(d) TIME AND MANNER OF MAKING YIELD ADJUSTMENT PAYMENTS. Yield adjustment payments must be made --

(1) Within 60 days of each excess earnings calculation date, and

(2) In accordance with procedures published by the Internal Revenue Service.

(e) YIELD ADJUSTMENT PAYMENT DEFINED -- (1) LAST PAYMENT. The yield adjustment payment (if any) for the last excess earnings calculation date is an amount chosen by the issuer that is not less than 100 percent of the excess earnings calculated as of that date.

(2) SPECIAL RULE FOR FIRST EXCESS EARNINGS CALCULATION DATE. If the first excess earnings calculation date with respect to an issue is not the last excess earnings calculation date for the issue, then the amount of the yield adjustment payment (if any) with respect to that date is an amount chosen by the issuer that is not less than 50 percent of the excess earnings calculated as of that date.

(3) SPECIAL RULE FOR SUBSEQUENT EXCESS EARNINGS CALCULATION DATES WHERE BONDS ARE OUTSTANDING. If an excess earnings calculation date is neither the first nor the last excess earnings calculation date for an issue, the amount of the yield adjustment payment (if any) with respect to that date is an amount chosen by the issuer that is not less than 75 percent of the excess earnings calculated for that date.

(f) DEFINITIONS -- (1) ACQUIRED PURPOSE OBLIGATION. The term "acquired purpose obligation" is defined in section 1.103- 13(b)(4)(iv)(A).

(2) ARBITRAGE BOND. The term "arbitrage bond" means a bond described in section 148(a).

(3) DEEMED REDEMPTION DATE. For any excess earnings calculation date for a bond, the term "deemed redemption date" means the earlier of --

(i) The maturity date of the bond, or

(ii) The first date, if any, which is after the excess earnings calculation date and on which the rate of interest borne by the bond may change to a rate not determinable prior to the excess earnings calculation date.

(4) ISSUE PRICE. The term "issue price" means the issue price calculated under sections 1273 and 1274.

(5) MATERIALLY HIGHER. The term "materially higher" is defined in section 1.148-10(b)(1)(i) with respect to acquired purpose obligations that the issuer elects to treat as acquired program obligations within the meaning of section 1.103-13(b)(5)(i) and is defined in section 1.103-13(b)(5) with respect to all other acquired purpose obligations.

(6) ORIGINAL ISSUE DISCOUNT. The term "original issue discount" is defined in section 1273(a)(1).

(7) QUALIFIED STUDENT LOAN BOND. The term "qualified student loan bond" is defined in section 144(b)(1)(A).

(8) STATED REDEMPTION PRICE AT MATURITY. The term "stated redemption price at maturity" is defined in section 1273(a)(2).

(g) EFFECTIVE DATE. This section applies to any qualified student loan bond issued after January 5, 1990.

There is a need for immediate guidance with respect to the provisions contained in this Treasury decision. For this reason, it is found impracticable to issue this Treasury decision with notice and public procedure under subsection (b) of section 553 of Title 5 of the United States Code or subject to the effective date limitation of subsection d) of that section.

Fred T. Goldberg, Jr.