SECTION 3. Scope and Application

3.1. Scope and General Rules . The IRS and the Treasury Department expect to promulgate regulations under § 150 to provide guidance on whether tax-exempt bonds are treated as reissued or retired solely for purposes of § 103 and §§ 141 through 150. Specifically, for purposes of § 103 and §§ 141 through 150 only, in the case of a qualified tender bond (as defined herein), any qualified interest rate mode change (as defined herein) and any qualified tender (as defined herein) will not be treated as a modification under § 1.1001–3. Therefore, for these purposes, a qualified tender bond will not be treated as reissued or retired solely as a result of a qualified interest rate mode change or the existence or exercise of any qualified tender. Further, in applying § 1.1001–3 to modifications of tax-exempt bonds, any interest rate variance directly related to a qualified interest rate mode change will not be treated as a modification under § 1.1001–3, and thus such interest rate variances need not be tested under the change in yield rule for determining significant modifications under § 1.1001–3(e)(2). Except as otherwise specially provided in this notice, the determination of whether any modification to an issue of tax-exempt bonds causes a reissuance or retirement of the tax-exempt bonds for purposes of § 103 and §§ 141 through 150 is based on whether the modifications are significant modifications under § 1.1001–3.

Similar to the treatment under Notice 88–130, and except as expressly provided herein with respect to the treatment of “qualified interest rate mode changes” and “qualified tenders” on “qualified tender bonds” (all as redefined herein), a tax-exempt bond generally is treated as reissued or retired on the first date on which: (1) a significant modification to the terms of the

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such a conversion. The Bonds are qualified tender bonds under § 3.2 of the notice.

On January 3, 2008, the auction interest rate on the Bonds is set at 10% as a consequence of a downgrade in the bond insurer’s credit rating from a AAA rating to a AA rating and associated market disruption. On January 10, 2008, the issuer amended the terms of the Bonds to replace the now AA-rated bond insurance with a AAA-rated bank letter of credit as credit enhancement, but otherwise made no other changes to the terms of the Bonds. On January 10, 2008, the auction rate on the Bonds floated down to 3% primarily as a result of the change in credit enhancement on the Bonds.

The amendment to the terms of the Bonds to change the credit enhancement is a modification to a recourse debt instrument that must be tested for significance under the change in security or credit enhancement rule in § 1.1001–3(e)(4)(iv). Because the change in security or credit enhancement did not cause a change in payment expectations on the Bonds ( i.e., the Bonds had an investment grade payment expectation before and after the change in credit enhancement), this change in credit enhancement is not a significant modification of the Bonds under § 1.1001–3 and thus does not cause a reissuance of the Bonds under § 103 and §§ 141 through 150. Further, the fact that the market impact of the change in credit enhancement caused the floating interest rate on the Bonds to float down from 10% to 3% is not required to be tested under the 25-basis point change in yield rule for significant modifications under § 1.1001–3(e)(2) because the Issuer has made no change to the interest rate-setting mechanism under the terms of the Bonds.

Example 2 . Exchange of Bonds to Remove Bond Insurance . Assume the same facts as in Example 1 above, except that, instead of amending the terms of the existing Bonds (the “Old Bonds”) to change the credit enhancement, on January 10, 2008, the Issuer issued new bonds with new Cusip numbers (the “New Bonds”) and did an actual exchange of the New Bonds for the Old Bonds. The New Bonds are not backed by any bond insurance or other credit enhancement. The New Bonds without the bond insurance have an A credit rating. There are no other differences between the New Bonds and the Old Bonds. The result would be the same as in Example 1 and no reissuance of the Bonds would occur. Section 1.1001–3 applies the same significant modification standard to amendments to the terms of an existing debt instrument and to actual exchanges of an existing debt instruments for a different debt instrument. Further, the same modification analysis under § 1.1001–3 would apply to an acquisition of an existing debt instrument for cash by an intermediary purchaser who is not an agent of or otherwise related to the issuer from an existing bondholder, an exchange of that acquired debt instrument for a modified debt instrument between such intermediary purchaser and the issuer and a subsequent sale by that intermediary purchaser to a different bondholder.

Example 3 . Impact of Authorized Changes in In- terest Rate Modes and Associated Mandatory Ten- ders . Assume the same facts as in Example 1 above, except that, on January 10, 2008, the Issuer also exercised its option under the terms of the Bonds to convert the interest rate mode on the Bonds from an auction rate mode to a fixed interest rate of 5% for the

its original issuance. Further, in order to be a qualified interest rate mode change, the terms of the bond must require that the bond be resold at a price equal to par upon conversion to a new interest rate mode, except that, upon a conversion to an interest rate mode that is a fixed interest rate for the remaining term of the bond to maturity, the bond may be resold at a market premium or a market discount from the stated principal amount of that bond.

(3). Qualified Tender . A “qualified tender” is either a tender option or a mandatory tender requirement that is authorized under the terms of the bond upon its original issuance and that meets the requirements of this Section 3.2(3). A bond is subject to a tender option or a tender requirement if the bondholder either has the option at specified times ( e.g., an ongoing tender option as part of the interest ratesetting process for tender option bonds) or the mandatory requirement upon specified occurrences ( e.g., a mandatory tender upon conversion from one interest rate mode to a different interest rate mode) to tender the bond for purchase or redemption at a price equal to par (which may include any accrued interest) pursuant to the terms of the bond on one or more tender dates before the final stated maturity date. A purchase of a bond pursuant to a tender option or mandatory tender requirement is treated as part of a qualified tender if the purchase occurs under the terms of the bond (regardless of whether the purchase is by the issuer, a liquidity provider, a remarketing agent, a bond trustee, a conduit borrower, or an agent of any of them), the terms of the bond require that at least best efforts be used to remarket the bond, and the bond is remarketed no later than 90 days after the date of such purchase.

3.3. Special Rule for Nonrecourse Debt . Solely for purposes of § 103 and §§ 141 through 150, in applying § 1.1001–3(e)(4)(iv)(B) to determine whether a modification of the security or credit enhancement on a tax-exempt bond that is a nonrecourse debt instrument is a significant modification, such a modification is treated as a significant modification only if the modification results in a change in payment expectations under § 1.1001–3(e)(4)(vi).

3.4. Special Temporary Relief for Cer- tain Waivers of Interest Rate Caps on Auc- tion Rate Bonds . Solely for purposes of

§ 103 and §§ 141 through 150, in applying § 1.1001–3(e)(2) to determine whether a modification to the yield on tax-exempt bonds that bear interest based on an auction rate constitutes a significant modification, a temporary waiver, in whole or in part, of the terms of a cap on the maximum interest rate on such auction rate bonds is disregarded to the extent that any agreement to waive such a cap and the period during which such a waiver is in effect both are within the period between November 1, 2007 and July 1, 2008. Except for the special relief provided in this section, a waiver of a cap on an interest rate on a tax-exempt bond generally is required to be tested for whether it causes a significant modification under § 1.1001–3.

3.5 Certain Modifications of Qualified Hedges for Arbitrage Purposes . Solely for purposes of the arbitrage investment restrictions under § 148, in determining whether a modification of a qualified hedge results in a termination of the hedge under § 1.148–4(h), such a modification is not treated as a termination of the hedge if both: (1) the modification is not reasonably expected as of the date of the modification to change the yield on the affected hedged bonds over the remaining term of the hedged bonds by more than one quarter of one percent (.25 percent or twenty-five basis points) per annum ; and (2) the payments and receipts on the qualified hedge, as modified, are fully taken into account as adjustments to the yield on those hedged bonds for arbitrage purposes under § 148.

3.6 Examples . The following examples illustrate the application of certain principles in this notice and § 1.1001–3 as they apply to tax-exempt bonds for purposes of this notice.

Example 1 . Insignificant Change in Credit En- hancement and Impact on Floating Interest Rate . On July 1, 2007, a municipality (the “Issuer”) issued $1 million in tax-exempt bonds that bear interest at an auction interest rate and that mature in 40 years (the “Bonds”). The Bonds are recourse obligations that are secured by the issuer’s underlying primary A-rated investment grade credit. The Bonds are secured further by credit enhancement under a bond insurance policy provided by a AAA-rated bond insurer. Pursuant to the terms of the Bonds, the auction interest rate on the Bonds resets every 7 days. The terms of the Bonds grant the issuer the option to convert the interest rate mode on the Bonds from an auction rate mode to either a 7-day tender option rate mode or to a long-term fixed interest rate to maturity, subject to a mandatory tender of the Bonds upon

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remaining term of the Bonds. The terms of the Bonds also required a mandatory tender and remarketing of the Bonds in connection with this interest rate mode change. The mandatory tender is a qualified tender and the change in the interest rate mode is a qualified interest rate mode change. Thus, the Bonds are qualified tender bonds, as defined in § 3.2 of the notice, the conversion of the interest rate on the Bonds from an auction rate mode to a fixed interest rate is pursuant to a qualified interest rate mode change” and the associated tender is qualified tender, all as defined in § 3.2 of the notice. Thus, under § 3.1 of the notice, in determining whether the Bonds are reissued for purposes of the tax-exempt bond provisions of the Code, the qualified interest rate mode change and the qualified tenders are not treated as modifications under § 1.1001–3. Furthermore, the interest rate change on the Bonds from a floating auction rate of 10% to a fixed interest rate of 5% was directly related to the qualified interest rate mode change and, under § 3.1 of the notice, also is not treated as a modification under § 1.1001–3. Finally, as in Example 1, no reissuance of the Bonds occurred for purposes of § 103 and §§ 141 to 150 as a result of the change in credit enhancement.

Example 4 . Impact of Unauthorized Changes . Assume the same facts as in Example 1, except that the terms of the Bonds do not provide for any conversions of the interest rate modes. On January 7, 2008, Issuer amends the Bond documents to allow the Issuer to convert the interest rate mode on the Bonds from an auction rate mode to either a 7-day tender option rate mode or to a long-term fixed interest rate to maturity, subject to a mandatory tender of the Bonds upon such a conversion. On January 10, 2008, Issuer exercised its option under the amended terms of the Bonds to convert the interest rate mode on the Bonds from an auction rate mode to a fixed interest rate of 5% for the remaining term of the Bonds. The Issuer also required a mandatory tender and remarketing of the Bonds in connection with this interest rate mode change.

Because the change in interest rate mode is not pursuant to the terms of the Bonds when originally issued, it is not a qualified interest rate mode change within the meaning of this notice. Similarly, the tender of the Bonds on January 10, 2008 was not pursuant to the terms of the Bond as originally issued and therefore was not a qualified tender within the meaning of this notice. Accordingly, the provisions of this notice are not applicable either to the interest rate mode change on the Bonds or to the tender of the Bonds. Thus, to determine whether these modifications cause a reissuance or retirement of the Bonds for purposes of § 103 and §§ 141 through 150, the impact of these modifications must be analyzed under § 1.1001–3 to determine whether a significant modification of the terms of the Bonds occurred.