4.9 Arbitrage Rebate

Since enactment of the Tax Reform Act of 1986, most bond financings have been subject to the arbitrage rebate requirement. To the extent that proceeds of bonds are allowed to be invested at a yield in excess of the bond yield and actually are invested at a higher yield, the Code requires that the excess (generally referred to as “arbitrage earnings”) must be rebated to the federal government. Thus, even though certain exceptions to the yield restriction requirements permit bond proceeds to be invested at an unrestricted yield during certain temporary periods, the rebate requirement generally requires that any arbitrage earnings be paid to the federal government. Issuers may, however, qualify for certain exceptions from arbitrage rebate liability as described below. In addition to bond proceeds held pending expenditure for the acquisition or construction of the project financed, the rebate requirement applies to arbitrage earnings on investments held in reasonably required reserve or replacement funds. However, earnings on bona fide DSFs for governmental bonds are exempt from the rebate requirement if the gross earnings on the DSF for a bond year are less than $100,000 or if the bonds have a fixed interest rate and an average maturity of at least 5 years.

The amount of an issuer’s arbitrage rebate liability, and the availability of applicable exceptions to that liability, are based on actual expenditures, not on the issuer’s expectations. Compliance with arbitrage rebate requirements is an important post issuance compliance requirement. See Section 8.3.5, Arbitrage Rebate. Public agency issuers generally engage an expert to provide arbitrage rebate calculation services.