4.3 What is an Issue of Debt?

4.3 What is an Issue of Debt?

For interest on a bond to be tax exempt, the bond must be debt under general federal tax law principles. Debt may take a variety of forms; generally, “debt” means an obligation to make payments on borrowed money. For federal tax law purposes, an obligation such as a lease may be treated as “debt.” even though it is not a debt for purposes of the California Constitution. A separately stated interest component, however, is generally a minimum requirement. Conversely, an obligation in the form of debt (e.g., a subordinate note) may be treated for tax purposes as equity and not debt if there is not a reasonable expectation that the principal and interest on the debt instrument will be paid when scheduled.

In general, the various federal tax limitations and requirements apply in the aggregate to an “issue” of bonds rather than separately to individual bonds. In other words, to determine whether bonds meet the applicable federal income tax requirements, one must first determine which bonds are part of the same issue in order to evaluate the requirements for that issue. In general, bonds will be treated as part of the same issue if the bonds are sold at substantially the same time (i.e., less than 15 days apart), are reasonably expected to be paid from substantially the same source of funds, and are sold under the same plan of finance (which is based on various factors including the purposes for the bonds and the structure of the financing). These rules apply for federal income tax purposes and may result in bonds issued as separate series or even under separate indentures being treated as a single issue. A single issue can include bonds of different tax classifications.