The Internal Revenue Service (“IRS”) has issued final regulations (the “Final Regulations”) on the definition of issue price to be published in the Federal Register on December 9, 2016 and with an effective date for Bonds that are sold on or after 180 days after publication. The Final Regulations amend existing definitions in the regulations under Section 148 of the Internal Revenue Code and replace regulations proposed by the IRS in 2015.
The definition of “issue price” is important for purposes of the arbitrage investment restrictions applicable to tax-exempt Bonds and other tax-exempt or tax-advantaged obligations (herein, “Bonds”). Generally, the issue price of an obligation determines the yield on the obligation, and arbitrage investment limitations or rebate requirements are applicable when the yield on an investment of the proceeds of Bonds exceeds the yield on the Bonds. The Final Regulations include several clarifications and additions that are important to participants in the tax-exempt bond markets.
The Final Regulations retain from the prior regulations the general rule that, for Bonds issued for money, the issue price is the first price at which a substantial amount of the Bonds is sold to the public. The Final Regulations also retain the definition of “substantial amount” as ten percent. The issue price of Bonds of an issue that do not have the same credit and payment terms is determined separately (so that, for instance, the issue price is determined separately for each maturity of an issue of serial bonds). The issue price is not reduced by any issuance costs.
Under the Final Regulations, if more than one rule for determining issue price is available for Bonds, such as both the general rule and one of the rules discussed below, for example, an issuer may select the rule it will use to determine the issue price for the Bonds at any time on or before the issue date of the Bonds. The issuer must identify the rule selected in its books and records maintained for the Bonds. The issuer need not apply the same rule to determine issue price for all of the Bonds in the issue. This means that, for instance, the issue price could be determined using different rules for different maturities. So the issue price for some maturities, where a substantial amount of the Bonds were sold, could be determined using the general rule, while the issue price for other maturities could be determined using the special rule discussed below.
The Final Regulations expressly provide that, for a Bond issued for money in a private placement to a single buyer that is not an underwriter or a related party to an underwriter, the issue price of the Bond is the price paid by that buyer. This clarification of the determination of issue price in private placements is particularly significant given the recent surge in direct placements with banks.
For this purpose, “underwriter” means:
(A) Any person that agrees pursuant to a written contract with the issuer (or with the lead underwriter to form an underwriting syndicate) to participate in the initial sale of the Bonds to the public; and
(B) Any person that agrees pursuant to a written contract directly or indirectly with a person described in paragraph (A) above to participate in the initial sale of the Bonds to the public (for example, a retail distribution agreement between a national lead underwriter and a regional firm under which the regional firm participates in the initial sale of the Bonds to the public).
“Public” means any person other than an underwriter or a related party to an underwriter.
The Final Regulations provide a special rule under which an issuer may treat the initial offering price to the public as the issue price of the Bonds as of the sale date if:
(1) The underwriters offered the Bonds to the public at a specified initial offering price on or before the sale date, and the lead underwriter in the underwriting syndicate or selling group (or, if applicable, the sole underwriter) provides, on or before the issue date, a certification to that effect to the issuer, together with reasonable supporting documentation for that certification, such as a copy of the pricing wire or equivalent communication; and
(2) each underwriter agrees in writing that it will neither offer nor sell the Bonds to any person at a price that is higher than the initial offering price during the period starting on the sale date and ending on the earlier of the close of the fifth (5th) business day after the sale date, or the date on which the underwriters have sold a substantial amount of the Bonds to the public at a price that is no higher than the initial offering price to the public.
This special rule would be used where a substantial amount of the Bonds has not been sold to the public so that the issuer could not use the general rule discussed above. Subject to satisfaction of the conditions, issuers now have a means of determining issue price where a substantial amount of the Bonds have not been sold to the public on the sale date.
COMPETITIVE SALE SPECIAL RULE
The Final Regulations provide that, for Bonds issued for money pursuant to an eligible competitive sale, an issuer may treat the reasonably expected initial offering price to the public of the Bonds as the issue price of the Bonds as of the sale date if the issuer obtains a certification from the winning bidder regarding the reasonably expected initial offering price to the public of the Bonds upon which the price in the winning bid is based.
For purposes of this special rule, the Final Regulations define competitive sale to mean a sale of Bonds by an issuer to an underwriter that is the winning bidder in a bidding process in which the issuer offers the Bonds for sale to underwriters at specified written terms and that meets the following requirements:
(1) The issuer disseminates the notice of sale to potential underwriters in a manner reasonably designed to reach potential underwriters;
(2) all bidders have an equal opportunity to bid;
(3) the issuer receives bids from at least three underwriters of municipal Bonds who have established industry reputations for underwriting new issuances of municipal Bonds; and
(4) the issuer awards the sale to the bidder who offers the highest price (or lowest interest cost).
The Final Regulations are a significant improvement over the prior issue price regulations. Of particular importance are the rules with respect to private placements and competitive sales. Issuers and underwriters should expect to see modifications to the certifications provided in the past with respect to issue price as the Final Regulations become effective.