Part IV. Items — Internal Revenue Bulletin 2002-16

trolled group means a group of entities controlled directly or indirectly by the same entity or group of entities. The determination of control is made on the basis of all the relevant facts and circumstances. One entity or group of entities (the controlling entity ) generally controls another entity or group of entities (the controlled entity ) if the controlling entity possesses either of the following rights or powers and the rights or powers are discretionary and non-ministerial: (i) the right or power both to approve and to remove without cause a controlling portion of the governing body of the controlled entity; or (ii) the right or power to require the use of funds or assets of the controlled entity for any purpose of the controlling entity.

Recently, questions have arisen regarding the application of these provisions with respect to certain issuances of bonds for 501(c)(3) organizations that operate hospital systems. In question, generally is whether bonds issued in connection with the combination of two or more 501(c)(3) organizations to refinance outstanding bonds should be characterized as refunding bonds. One question is how the change in obligor exception and the sixmonth exception should be applied when the obligor of the new issue becomes related to the obligor of the other issue as part of the refinancing transaction. Another question is whether the acquisition by a 501(c)(3) organization of the sole membership interest in another 501(c)(3) organization should be treated as an asset acquisition for purposes of the six-month exception. A third question is what assets should be treated as financed by the new bonds under both the change in obligor exception and the six-month exception.

In general, the proposed regulations retain the change in obligor exception and the six-month exception, with certain modifications. The proposed regulations clarify that the determination of whether persons are related for purposes of the change in obligor exception and the sixmonth exception is generally made immediately before the transaction. However, a refinancing issue is a refunding issue under the proposed regulations if the obligor of the refinanced issue (or any person

Notice of Proposed Rulemaking and Notice of Public Hearing

Obligations of States and Political Subdivisions

REG–165706–01

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations on the definition of refunding issue applicable to tax-exempt bonds issued by States and local governments. This document provides a notice of public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by July 9, 2002. Outlines of topics to be discussed at the public hearing scheduled for July 30, 2002, at 10 a.m., must be received by July 9, 2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG–165706–01), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG–165706– 01), courier’s desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, submissions may be made electronically to the IRS Internet site at www.irs.gov/regs . The public hearing will be held in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Michael P. Brewer (202) 622–3980; concerning submissions and the hearing, Treena Garrett (202) 622–7190 (not tollfree numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 150 of the Internal Revenue Code (Code) provides certain definitions and special rules for purposes of applying the tax-exempt bond limitations contained in sections 103 and 141 through 150. On June 18, 1993, final regulations (T.D. 8476, 1993–2 C.B. 13) under section 150 were published in the Federal Register (58 FR 33510). On May 9, 1997, additional final regulations (T.D. 8718, 1997–1 C.B. 47) under section 150 were published in the Federal Register (62 FR 25502). This document proposes to modify the definition of refunding issue under § 1.150–1(d).

Explanation of Provisions

Section 1.150–1(d) of the current regulations provides a definition of refunding issue . In general, a refunding issue is an issue of obligations the proceeds of which are used to pay principal, interest, or redemption price on another issue. The current regulations contain certain exceptions to this general rule. One exception (the change in obligor exception ) provides that an issue is not a refunding issue to the extent that the obligor of one issue is neither the obligor of the other issue nor a related party with respect to the obligor of the other issue. Another exception (the six-month exception ) provides that if a person assumes (including taking subject to) obligations of an unrelated party in connection with an asset acquisition (other than a transaction to which section 381(a) applies if the person assuming the obligation is the acquiring corporation within the meaning of section 381(a)), and the assumed issue is refinanced within six months before or after the date of the debt assumption, the refinancing issue is not treated as a refunding issue.

Section 1.150–1(b) of the current regulations provides that the term related party means, in reference to a governmental unit or a 501(c)(3) organization, any member of the same controlled group. Section 1.150–1(e) of the current regulations provides that the term con-

April 22, 2002 787 2002–16 I.R.B.

visitors will not be admitted beyond the lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must submit written comments by July 9, 2002, and submit an outline of the topics to be discussed and the amount of time to be devoted to each topic by July 9, 2002.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Bruce M. Serchuk, Office of Chief Counsel (Tax Exempt and Government Entities), Internal Revenue Service and Stephen J. Watson, Office of Tax Legislative Counsel, Department of the Treasury. However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read as follows:

Authority: 26 U.S.C. 7805 - - Par. 2. Section 1.150–1 is amended as follows:

Paragraph (a)(2)(iii) is added.
Paragraphs (d)(2)(ii) and (d)(2)(v) are revised.

The added and revised provisions read as follows:

§ 1.150–1 Definitions .

(a) - - (2) - - (iii) Special effective date for para- graphs (d)(2)(ii) and (d)(2)(v) . Paragraphs (d)(2)(ii) and (d)(2)(v) of this section apply to bonds sold on or after the

that is related to the obligor of the refinanced issue immediately before the transaction) has or obtains in the transaction the right to appoint the majority of the members of the governing body of the obligor of the refinancing issue (or any person that controls the obligor of the refinancing issue).

The proposed regulations state that the six-month exception applies to acquisi- tion transactions . An acquisition transaction is a transaction in which a person acquires from an unrelated party: (i) assets, other than an equity interest in an entity, if the acquirer is treated as acquiring such assets for all Federal income tax purposes; (ii) stock of a corporation with respect to which a valid election under section 338 is made; or (iii) control of a governmental unit or a 501(c)(3) organization through the acquisition of stock, membership interests or otherwise.

The proposed regulations retain the exclusion under which the six-month exception does not apply to transactions to which section 381(a) applies, and broaden its scope. In particular, under the proposed regulations the exclusion may apply even if the person assuming the obligations is not the acquiring corporation within the meaning of section 381(a) (for example, a transaction in which a corporation assumes the obligations of a target corporation in a transaction to which section 381(a) applies and then contributes all of the assets of the target corporation to a controlled subsidiary). The proposed regulations also extend the application of this rule for section 381(a) transactions to the change in obligor exception.

The proposed regulations provide two new, additional requirements for purposes of the change in obligor exception and the six-month exception. In certain circumstances where the obligors of the issues are affiliated before the transaction or become affiliated as part of the transaction, the proposed regulations provide that an issue will be treated as a refunding issue unless: (i) the refinanced issue is redeemed on the earliest date on which the issue may be redeemed, and (ii) the new issue is treated as being used to finance the assets that were financed with the proceeds of the refinanced issue. These new requirements are intended to

further the Congressional policy against overburdening the tax-exempt bond market, as expressed in sections 148 and 149(d). In particular, they are intended to prevent overburdening in the case of transactions between affiliated persons that contain certain economic characteristics of a refunding.

Proposed Effective Date

The proposed regulations will apply to bonds sold on or after the date of publication of final regulations in the Federal Register . However, issuers may apply the proposed regulations in whole, but not in part, to any issue that is sold on or after the date the proposed regulations are published in the Federal Register and before the applicability date of the final regulations.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments that are submitted timely (preferably a signed original and eight copies) to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for July 30, 2002, at 10:00 a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Because of access restrictions,

2002–16 I.R.B. 788 April 22, 2002

date of publication of final regulations in the Federal Register, and may be applied by issuers in whole, but not in part, to any issue that is sold on or after April 10, 2002.

- - - (d) - - (2) - - (ii) Certain issues with different obligors —(A) In general . An issue is not a refunding issue to the extent that the obligor (as defined in paragraph (d)(2)(ii)(B) of this section) of one issue is neither the obligor of the other issue nor a related party with respect to the obligor of the other issue. The determination of whether persons are related for this purpose is generally made immediately before the issuance of the refinancing issue. This paragraph (d)(2)(ii)(A) does not apply to any issue that is issued in connection with a transaction to which section 381(a) applies.

(B) Definition of obligor . The obligor of an issue means the actual issuer of the issue, except that the obligor of the portion of an issue properly allocable to an investment in a purpose investment means the conduit borrower under that purpose investment. The obligor of an issue used to finance qualified mortgage loans, qualified student loans, or similar program investments (as defined in § 1.148–1) does not include the ultimate recipient of the loan ( e.g., the homeowner, the student).

(C) Certain integrated transactions . If, within six months before or after a person assumes (including taking subject to) obligations of an unrelated party in connection with an acquisition transaction (other than a transaction to which section 381(a) applies), the assumed issue is refinanced, the refinancing issue is not a refunding issue. An acquisition transaction is a transaction in which a person acquires from an unrelated party—

( 1 ) Assets (other than an equity interest in an entity);

( 2 ) Stock of a corporation with respect to which a valid election under section 338 is made; or ( 3 ) Control of a governmental unit or a 501(c)(3) organization through the acquisition of stock, membership interests or otherwise.

(D) Special rule for affiliated persons . Paragraphs (d)(2)(ii)(A) and (C) of this

section do not apply to any issue that is issued in connection with a transaction between affiliated persons (as defined in paragraph (d)(2)(ii)(E) of this section), unless—

( 1 ) The refinanced issue is redeemed on the earliest date on which it may be redeemed (or otherwise within 90 days after the date of issuance of the refinancing issue); and

( 2 ) The refinancing issue is treated for all purposes of sections 103 and 141 through 150 as financing the assets that were financed with the refinanced issue.

(E) Affiliated persons . For purposes of paragraph (d)(2)(ii)(D) of this section, persons are affiliated persons if—

( 1 ) At any time during the six months prior to the transaction, more than 5 percent of the voting power of the governing body of either person is in the aggregate vested in the other person and its directors, officers, owners, and employees; or

( 2 ) During the one-year period beginning six months prior to the transaction, the composition of the governing body of the acquiring person (or any person that controls the acquiring person) is modified or established to reflect (directly or indirectly) representation of the interests of the acquired person or the person from whom assets are acquired (or there is an agreement, understanding, or arrangement relating to such a modification or establishment during that one-year period).

(F) Reverse acquisitions . Notwithstanding any other provision of this paragraph (d)(2)(ii), a refinancing issue is a refunding issue if the obligor of the refinanced issue (or any person that is related to the obligor of the refinanced issue immediately before the transaction) has or obtains in the transaction the right to appoint the majority of the members of the governing body of the obligor of the refinancing issue (or any person that controls the obligor of the refinancing issue). See paragraph (d)(2)(v) Example 2 of this section.

- - - (v) Examples . The provisions of this paragraph (d)(2) are illustrated by the following examples:

Example 1 . Consolidation of 501(c)(3) hospital organizations . (i) A and B are unrelated hospital organizations described in section 501(c)(3). A has assets with a fair market value of $175 million, and is the obligor of outstanding tax-exempt bonds in the amount of $75 million. B has assets with a fair

market value of $145 million, and is the obligor of outstanding tax-exempt bonds in the amount of $50 million. In response to significant competitive pressures in the healthcare industry, and for other substantial business reasons, A and B agree to consolidate their operations. To accomplish the consolidation, A and B form a new 501(c)(3) hospital organization, C. A and B each appoint one-half of the members of the initial governing body of C. Subsequent to the initial appointments, C’s governing body is self-perpetuating. On December 29, 2003, State Y issues bonds with sale proceeds of $129 million and lends the entire sale proceeds to C. The 2003 bonds are collectively secured by revenues of A, B, and C. Simultaneously with the issuance of the 2003 bonds, C acquires the sole membership interest in each of A and B. C’s ownership of these membership interests entitles C to exercise exclusive control over the assets and operations of A and B. C uses the $129 million of sale proceeds of the 2003 bonds to defease the $75 million of bonds on which A was the obligor, and the $50 million of bonds on which B was the obligor. All of the defeased bonds will be redeemed on the first date on which they may be redeemed. In addition, C treats the 2003 bonds as financing the same assets as the defeased bonds. The 2003 bonds do not constitute a refunding issue because the obligor of the 2003 bonds (C) is neither the obligor of the defeased bonds nor a related party with respect to the obligors of those bonds immediately before the issuance of the 2003 bonds. In addition, the requirements of paragraph (d)(2)(ii)(D) of this section have been satisfied.

(ii) The facts are the same as in paragraph (i) of this Example 1, except that C acquires the membership interests in A and B subject to the obligations of A and B on their respective bonds, and the 2003 bonds are sold within six months after the acquisition by C of the membership interests. The 2003 bonds do not constitute a refunding issue.

Example 2 . Reverse acquisition . D and E are unrelated hospital organizations described in section 501(c)(3). D has assets with a fair market value of $225 million, and is the obligor of outstanding taxexempt bonds in the amount of $100 million. E has assets with a fair market value of $100 million. D and E agree to consolidate their operations. On May 18, 2004, Authority Z issues bonds with sale proceeds of $103 million and lends the entire sale proceeds to E. Simultaneously with the issuance of the 2004 bonds, E acquires the sole membership interest in D. In addition, D obtains the right to appoint the majority of the members of the governing body of E. E uses the $103 million of sale proceeds of the 2004 bonds to defease the bonds of which D was the obligor. All of the defeased bonds will be redeemed on the first date on which they may be redeemed. In addition, E treats the 2004 bonds as financing the same assets as the defeased bonds. The 2004 bonds constitute a refunding issue because the obligor of the defeased bonds (D) obtains in the transaction the right to appoint the majority of the members of the governing body of the obligor of the 2004 bonds (E). See paragraph (d)(2)(ii)(F) of this section.

Example 3 . Relinquishment of control . The facts are the same as in Example 2, except that D does not obtain the right, directly or indirectly, to appoint any member of the governing body of E. Rather, E obtains the right both to approve and to remove

April 22, 2002 789 2002–16 I.R.B.

sale or exchange of the stock which is not recognized by the corporation under section 1032.

Accordingly, the proposed regulations revise the purpose statement of § 1.705– 2(a) to take into account situations involving such partnership distributions. The proposed regulations provide a specific rule implementing the revised purpose in single partnership cases. The proposed regulations also revise § 1.705–2(c) to clarify that the tiered partnerships rule applies to situations involving such partnership distributions.

In addition, the proposed regulations clarify that references in the regulations to stock of a corporate partner include any position in stock of a corporate partner to which section 1032 applies.

Proposed Effective Date

The regulations are proposed to apply to sales or exchanges of stock occurring after March 29, 2002.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) that are timely submitted to the IRS. The IRS and the Treasury Department request comments on the clarity of the proposed rule and how it may be made easier to understand. All comments will be available for public inspection and copying. A

without cause each member of the governing body of D. In addition, prior to being acquired by E, D experiences financial difficulties as a result of mismanagement. Thus, as part of E’s acquisition of D, all of the former members of D’s governing body resign their positions and are replaced with persons appointed by E. The 2004 bonds do not constitute a refunding issue.

- - - Robert E. Wenzel, Deputy Commissioner of

Internal Revenue .

(Filed by the Office of the Federal Register on April 5, 2002, 2:41 p.m., and published in the issue of the Federal Register for April 10, 2002, 67 F.R. 17309)

Notice of Proposed Rulemaking

Amendments to Rules for Determination of Basis of Partner’s Interest; Special Rules

REG–167648–01

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations relating to special rules on determination of basis of a partner’s interest under section 705. The proposed regulations are necessary to coordinate sections 705 and 1032.

DATES: Written or electronic comments and requests for a public hearing must be received by June 27, 2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG–167648–01), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG–167648–01), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit comments electronically directly to the IRS internet site at www.irs.gov/regs .

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Barbara MacMillan or Rebekah A. Myers, (202) 622–3050; concerning submissions of comments or requests for a hearing, LaNita VanDyke at (202) 622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

On January 3, 2001, the Treasury Department and the IRS published a notice of proposed rulemaking (REG– 106702–00, 2001–4 I.R.B. 424) under section 705 of the Internal Revenue Code (Code) in the Federal Register (66 FR 315). Those proposed regulations provided guidance on the coordination of sections 705 and 1032 in situations where a corporation acquires an interest in a partnership that holds stock in that corporation, a section 754 election is not in effect with respect to the partnership for the taxable year in which the corporation acquires the interest, and the partnership later sells or exchanges the stock. Final regulations for the issues addressed in those proposed regulations are being published elsewhere in T.D. 8986. These proposed regulations propose to revise the final regulations contained in § 1.705–2 of 26 CFR part 1 to address remaining issues that Treasury and the IRS considered during the development of the final regulations.

Explanation of Provisions

These proposed regulations provide guidance in situations in which a corporation owns a direct or indirect interest in a partnership that owns stock in that corporation, the partnership distributes money or other property to another partner and that partner recognizes gain on the distribution during a year in which the partnership does not have an election under section 754 in effect, and the partnership subsequently sells or exchanges the stock. For reasons similar to those explained in the preamble of the final regulations, in those situations it may be inconsistent with the intent of sections 705 and 1032 to increase the basis of the corporation’s partnership interest by the full amount of any gain resulting from the partnership’s

2002–16 I.R.B. 790 April 22, 2002

public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Reg- ister .

Drafting Information

The principal author of these proposed regulations is Barbara MacMillan of the Office of the Associate Chief Counsel (Passthroughs and Special Industries). However, personnel from other offices of the IRS and the Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 - - Par. 2. Section 1.705–1 is amended by revising paragraph (a)(7) to read as follows:

§ 1.705–1 Determination of basis of part- ner’s interest .

(a) - - (7) For basis adjustments necessary to coordinate sections 705 and 1032 in certain situations in which a partnership disposes of stock or any position in stock to which section 1032 applies of a corporation that holds a direct or indirect interest in the partnership, see § 1.705–2.

- - - Par. 3. Section 1.705–2 is amended as follows:

Paragraph (a) is amended by adding a new sentence after the third sentence.
Paragraph (b) is amended by adding paragraph (b)(2).
Paragraph (c)(1) is amended by adding a new sentence after the second sentence.
Paragraph (d) is added.
Paragraph (e) is amended by removing the period at the end of the paragraph and adding a new phrase at the end of the paragraph.

The additions and revision read as follows:

§ 1.705–2 Basis adjustments coordinating sections 705 and 1032 .

(a) - - - Similarly, in situations where a section 754 election was not in effect for the year in which a partnership distributes money or other property to another partner and that partner recognizes gain on the distribution, the remaining partners’ inside basis and outside basis may not be equal. - -

- - - (b) - - (2) Required adjustments relating to distributions . (i) This paragraph (b)(2) applies in situations where a corporation owns a direct or indirect interest in a partnership that owns stock in that corporation, the partnership distributes money or other property to another partner and that partner recognizes gain on the distribution during a year in which the partnership does not have an election under section 754 in effect, and the partnership subsequently sells or exchanges the stock. In these situations, the increase (or decrease) in the corporation’s adjusted basis in its partnership interest resulting from the sale or exchange of the stock equals the amount of gain (or loss) that the corporate partner would have recognized (absent the application of section

if, for the year in which the partnership made the distribution, a section 754 election had been in effect. (ii) The provisions of this paragraph (b)(2) are illustrated by the following example:

Example . (i) A, B, and corporation C form partnership PRS. A and B each contribute $10,000 and C contributes $20,000 in exchange for a partnership interest. PRS has no liabilities. PRS purchases stock in corporation C for $10,000, which appreciates in value to $70,000. PRS distributes $25,000 to A in complete liquidation of A’s interest in PRS in a year for which an election under section 754 is not in effect. PRS later sells the C stock for $70,000. PRS realizes a gain of $60,000 on the sale of the C stock. C’s share of the gain is $40,000. Under section 1032, C does not recognize its share of the gain. (ii) Normally, C would be entitled to a $40,000 increase in the basis of its PRS interest for its allocable share of PRS’s gain from the sale of the C stock, but a special rule applies in this situation. If a section 754 election had been in effect for the year in which PRS made the distribution to A, PRS would have been entitled to adjust the basis of partnership property under section 734(b)(1)(A) by $15,000 (the amount of gain recognized by A with

respect to the distribution to A under section 731(a)(1)). See § 1.734–1(b). Under § 1.755– 1(c)(1)(ii), the basis adjustment under section 734(b) would have been allocated to the C stock, increasing its basis to $25,000. (Where there is a distribution resulting in an adjustment under section 734(b)(1)(A) to the basis of undistributed partnership property, the adjustment is allocated only to capital gain property.)

(iii) If a section 754 election had been in effect for the year in which PRS made the distribution to A, the amount of gain that PRS would have recognized upon PRS’s disposition of C stock would be $45,000 ($70,000 minus $25,000 basis in the C stock), and the amount of gain C would have recognized upon PRS’s disposition of the C stock (absent the application of section 1032) would be $30,000 (C’s share of PRS’s gain of $45,000 from the stock sale). Accordingly, upon PRS’s sale of the C stock, the increase in the basis of C’s interest in PRS is $30,000.

- - - (c)(1) - - - Similarly, if a corporation owns an indirect interest in its own stock through a chain of two or more partnerships, and a partnership in the chain distributes money or other property to another partner and that partner recognizes gain on the distribution during a year in which the partnership does not have an election under section 754 in effect, then upon any subsequent sale or exchange of the stock, the bases of the interests in the partnerships included in the chain shall be adjusted in a manner that is consistent with the purpose of this section.
- - - (d) Positions in Stock . For purposes of this section, stock includes any position in stock to which section 1032 applies.

(e) - - -, except that the fourth sentence of paragraph (a), paragraph (b)(2), and the third sentence of paragraph (c)(1) of this section are applicable with respect to sales or exchanges of stock occurring on or after March 29, 2002.

Robert E. Wenzel, Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on March 28, 2002, 8:45 a.m., and published in the issue of the Federal Register for March 29, 2002, 67 F.R. 15132)

April 22, 2002 791 2002–16 I.R.B.

Yield on an issue will be equal to the yield on the issue under § 148. If all or a portion of the refinancing bonds bear interest at a variable rate, the variable rate will be equal to the actual values of the variable rate of the refinancing bonds from the issue date until the date of any closing agreement, and the reasonably expected values of the variable rate for the remaining term of the refinancing bonds. Expectations regarding values will be treated as reasonable if the values are equal to the value of an objective index of tax-exempt variable rates (similar to the variable rate on the refinancing bonds) on the date of the closing agreement.

Restructuring Option

Any restructuring must be completed within 180 of days of the execution of the closing agreement. To the extent that a restructuring involves the redemption of bonds, the issuer must provide a written notice to the bondholders similar to the notice described in § 5.02(5) of Rev. Proc. 97–15 (1997–1 C.B. 635).

Allocations of proceeds to bonds for non-qualified purposes of § 145(a)(2) will be treated as reasonable if made consistently with the rule set forth in § 1.141– 12(j)(2).

Submissions

Submissions with regard to the closing agreement program should be directed to:

Clifford J. Gannett Manager, Outreach, Planning

and Review Internal Revenue Service Attn: T:GE:TEB:O, Room 5T2 1111 Constitution Avenue, N.W. Washington, D.C. 20224

Drafting Information

The principal authors of this announcement are Bruce M. Serchuk of the Office of Associate Chief Counsel (Tax Exempt and Government Entities) and W. Mark Scott of the Office of Tax Exempt Bonds, Tax Exempt and Government Entities Division. For further information regarding this announcement, contact W. Mark Scott at (202) 283–9815 (not a toll-free call).

Hospital Refinancing Closing Agreement Program

Announcement 2002–43

Purpose

The Internal Revenue Service (the “Service”), Office of Tax Exempt Bonds, announces a program under which certain issuers of state or local bonds may request a closing agreement pursuant to which bonds (the “refinancing bonds”) issued to refinance certain outstanding bonds (the “refinanced bonds”) will be recognized as acquisition bonds (and therefore will not be treated as a refunding issue under § 1.150–1(d) of the Income Tax Regulations) and the allocations of proceeds to expenditures for such bonds will be respected.

Background

The closing agreement program applies to issues of state or local bonds issued in connection with hospital affiliation transactions where two or more existing 501(c)(3) organizations (the “Sellers”) agreed to merge their operations by selling either the assets of the Sellers or control of the Sellers to a new or preexisting 501(c)(3) organization that the Sellers jointly control. In particular, the program applies where the issuer did not characterize the refinancing bonds as a refunding issue under § 1.150–1(d)(2) and did not treat proceeds of the refinancing bonds as being used for all of the purposes for which the proceeds of the refinanced bonds were used. The Service is providing the program because it recognizes the policy reasons for the hospital affiliation transactions and the uncertainty in applying the allocation rules and has a desire to quickly and fairly resolve the examinations of the refinancing bonds.

On April 10, 2002, proposed regulations were published relating to the definition of refunding under § 1.150–1(d). Issuers may apply the proposed regulations in whole, but not in part, to any issue that is sold on or after the date the proposed regulations were published in

the Federal Register and before the effective date of the final regulations.

Closing Agreement Procedure

An issuer seeking relief must execute a closing agreement with the Service on or before December 31, 2002, following the procedures in this announcement. An issue of bonds is eligible for the program whether or not it is under examination. The closing agreement will be prepared by the Service and, in general, will be in substantially the same form as the model closing agreement set forth in IRM 7.6.2. For issues that are not under examination, issuers should submit a request for closing agreement pursuant to Notice 2001–60 (2001–40 I.R.B. 304). As a condition to executing a closing agreement, the issuer must agree to take one of the following actions:

Pay, simultaneously with the execution by the issuer of the closing agreement, the applicable closing agreement amount (as described below). Proceeds of tax-exempt bonds may not be used to pay the closing agreement amount.
Treat the proceeds of the refinancing bonds as used for the purposes for which the proceeds of the refinanced issue were used and restructure the refinancing bonds in a manner such that the bonds comply with the applicable requirements of §§ 103 and 141 through 150 of the Internal Revenue Code that are impacted by such allocation.

Closing Agreement Amount

The closing agreement amount is equal to 30 percent of the present value of the arbitrage profit on the escrow investments that were purchased with the proceeds of the refinancing bonds to be used to repay the refinanced bonds, plus interest accruing at the underpayment rate under § 6621, beginning on the date that is 60 days from April 10, 2002. Arbitrage profit is the excess of the amount earned on the escrow investments over the amount that would have been earned if the investments bore a yield equal to the yield on the refinancing bonds. Present value is computed as of the issue date of the refinancing bonds, using the yield on the refinancing bonds as the discount rate.

2002–16 I.R.B. 792 April 22, 2002