Tax simplification 101: an arbitrage rebate safe-harbor proposal.

• Author: Spain, Catherine L.
• Position: Government Finance Officers Assn's safe-harbor proposal

Tax simplification is not a new idea, but it is one that is getting more attention as Congress and the administration look for ways to ease administrative burdens on the beleaguered Internal Revenue Service (IRS) and taxpayers. In a recent letter to the U.S. Treasury Department responding to a request for help in identifying areas of the federal income tax code that could be simplified, GFOA unveiled a proposal it developed in cooperation with the National Association of Counties (NACo) calling for a new arbitrage rebate safe harbor. The National League of Cities has joined this effort, and other national organizations are expected to support this initiative after their members have an opportunity to review the proposal.

Exhibit 1 ARBITRAGE REBATE PAYMENTS(*) Arbitrage Rebate Amount Year of Issue Number of Issues (in millions) 1984-1989 360 $67.9 1989 879 297.5 1989-1994 149 23.0 Pre-1984 or unknown 3 .1 Total 1,391 $388.5 Type of Issue Governmental 863 $264.4 Private activity 525 123.5 Unknown 3 .6 Total 1,391 $388.5 Size of Issue ($ millions) 0-5 242 $6.5 5.1-10 338 26.1 10.1-15 151 21.3 15.1-20 111 19.1 20.1-25 87 19.1 25.1-50 220 75.3 50.1-100 150 87.3 100.1-200 44 62.4 Over 200 29 69.3 Unknown 19 2.1 Total 1,391 $388.5 Size of Rebate Payment ($) 0-1,000 36 [less than].1 1,001-10,000 158 .7 10,001-100,000 565 26.0 100,001-1,000,000 546 174.0 Over 1,000,000 86 187.8 Total 1,391 $388.5 * Data obtained from 8038Ts filed in 1994. Source: "Tax-Exempt Bonds: Do the Arbitrage Rules Work?" by Bruce F. Davie Safe-harbor Proposal's Provisions

One way to provide meaningful simplification of the federal arbitrage restrictions is to change the mechanics for determining the need to make an arbitrage rebate payment prior to the sale of a municipal tax-exempt bond. The proposed safe harbor sets forth six criteria to identify bond issues that are essentially plain-vanilla issues and not transactions where any significant arbitrage is earned. An issuer of municipal tax-exempt bonds (or a borrower from a pool) would not be deemed to have earned arbitrage subject to the rebate requirement if all of the following criteria are met:

* the issue is a new money issue;

* the issuer reasonably expects to spend 15 percent of the bond proceeds within one year of the date of the bond issue and at least 95 percent within three years of the date of issue;

* the bonds are exempt from the state-by-state volume cap;

* the bonds are fixed-rate;

* the bonds are long-term...