SECTION 2. Background

Reissuance

Reissuance of a tax-exempt bond for purposes of the tax-exempt bond provisions triggers retesting of all the various program requirements for new issues of tax-exempt bonds. A reissuance of an issue of tax-exempt bonds may result in various negative consequences to a bond issuer, including, among other things, changes in yield for purposes of the arbitrage investment restrictions, acceleration of arbitrage rebate payment obligations, deemed terminations of integrated interest rate swaps under the qualified hedge rules for arbitrage purposes, new public ap

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to tender their bonds for purchase at par at specified intervals, typically every seven days. Tender option bonds generally have creditworthy third-party liquidity facilities from banks or other liquidity providers to support the tender options and may have credit enhancement from bond insurers or other providers. Tender option bonds also may have interest mode conversion options which grant to the issuer or a conduit borrower an option to change the interest rate mode on the bonds from a tender option mode to another short-term interest rate mode or to a fixed interest rate to maturity. At the time of a conversion to another interest rate mode, tender option bonds typically are subject to a mandatory tender for purchase but a bondholder may be allowed to elect to retain the bonds. Upon the exercise of ongoing tender options associated with the short-term interest rate-setting mechanism for tender option bonds and upon any mandatory or optional tender upon conversion of the interest rate on the bonds to another interest rate mode, a remarketing agent or a liquidity provider typically will acquire the bonds subject to the tender at par and resell the bonds either to the same bondholders or to others willing to purchase such bonds. In general, Notice 88–130 provides guidance for when the tenders associated with tender option bonds will not constitute reissuances if they meet the specific detailed eligibility requirements for “qualified tender bonds,” as defined in Notice 88–130.

Another interest rate mode used with tax-exempt bonds is an auction rate mode. The interest rate on auction rate bonds is reset at predetermined intervals (generally under one year) using a modified Dutch auction process. Auction rate bonds generally trade at par and are callable at par on any interest payment date at the option of the issuer. Unlike bonds in a tender option mode, however, bonds in an auction rate mode have no ongoing tender options or put options to support the interest rate-setting process. Thus, auction rate bonds are viewed as long-term investments with a short-term interest rate-setting process. Auction rate bonds generally have maximum rates based on state law restrictions or certain formulas, such as a multiple of a tax-exempt or taxable index. Auction rate bonds may have credit enhancement from bond insurers or other providers. Auction rate bonds also may have interest mode

proval requirements for qualified private activity bonds, and change in law risk.

In general, the standard for determining whether tax-exempt bonds are reissued, retired, or otherwise modified significantly enough to trigger a retesting of the program requirements for new issues of tax-exempt bonds under the tax-exempt bond provisions of the Code is based on the general Federal tax standards for debt exchanges under § 1001 and regulations thereunder.

In general, § 1.1001–3 employs a significant modification standard to determine whether modifications to a debt instrument in any form are sufficiently significant to cause the debt instrument to be treated as reissued or exchanged for purposes of § 1001. Section 1.1001–3 applies to modifications in the form of amendments to the terms of an existing debt instrument and to modifications in the form of actual exchanges of existing debt instruments for different debt instruments. The determination of whether a resulting debt instrument is treated as a reissued new debt instrument or a continuation of the original debt instrument depends on whether the result represents a “significant modification” of the original debt instrument, as defined in § 1.1001–3.

Notice 88–130 provides certain special reissuance rules for certain eligible taxexempt bonds that are “qualified tender bonds,” as defined therein. Notice 88–130 provides that qualified tender bonds will not be treated as reissued for purposes of § 103 and §§ 141 through 150 as a result of certain tender rights and certain changes in interest rate modes and other terms of bonds that are covered specifically by the detailed rules and limitations set forth in Notice 88–130.

Debt Extinguishment

Subject to limited exceptions, a debt instrument generally is treated as retired or extinguished when, among other circumstances, an issuer acquires its own debt because a merger of the interests of the issuer and the holder occurs. Notice 88–130 reflects this debt extinguishment principle in § 2.2(d) thereof, which generally treats a tax-exempt qualified tender bond as retired if it is purchased or otherwise acquired by or on behalf of an issuer which is a governmental unit or an agency or instrumentality

thereof. If tax-exempt bonds treated as retired as a result of a debt extinguishment upon a governmental issuer’s purchase of the tax-exempt bonds, that treatment may have different consequences depending on whether it is retired with the proceeds of another debt instrument or whether it is retired from equity or other non-borrowed funds.

A borrowing, whether taxable or taxexempt, that is treated as retiring or reissuing a separate borrowing, generally constitutes an issue of refunding bonds which are viewed as financing the same governmental purpose or project as the original bonds (or “stepping into the shoes” of the original bonds) and trigger consequences involving the need to retest certain tax-exempt bond program requirements.

Tax-exempt bonds that are treated as retired through a debt extinguishment without a link to another borrowing, such as potentially an issuer’s purchase of its own tax-exempt bonds using equity or other non-borrowed funds, may trigger additional consequences, including the potential adverse consequence of generally limiting the ability to refinance those extinguished bonds later with tax-exempt refunding bonds for the same governmental purpose as the original bonds.

Interest Rate Modes—Tender Option Modes and Auction Rate Modes

Issuers may issue fixed rate tax-exempt bonds that bear interest at fixed rates to maturity or variable rate bonds that bear interest at variable rates which float periodically in accordance with various marketbased interest-rate setting mechanisms. Issuers often include multi-modal interest rate features in the preauthorized terms of the bond documents which provide issuers with the flexibility to change interest rate modes under parameters set forth in the bond documents.

One common interest rate mode employed with tax-exempt bonds is a tender option mode. “Tender option bonds” are also referred to commonly as “variable rate demand bonds.” Tender option bonds have short-term interest features tied to current market rates necessary to remarket the bonds at par. Tender option bonds have ongoing tender options or put options associated with the interest rate-setting mechanism which allow bondholders

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(1). Qualified Tender Bond . The term “qualified tender bond” means a tax-exempt bond that has all of the following features: (a) for each interest rate mode that is preauthorized under the terms of the bond considered separately, the bond bears interest during the allowable term of that interest rate mode at either a fixed interest rate, a variable interest rate that constitutes a qualified floating rate on a variable rate debt instrument for a tax-exempt bond under § 1.1275–5(b) ( e.g ., various interest rate indexes and rate-setting mechanisms that reasonably can be expected to measure contemporaneous variations in the cost of newly-borrowed funds, including, without limitation, interest rates determined by reference to eligible interest rate indexes (e.g ., the SIFMA index), tender option-based interest rate measures, or a Dutch auction process), or a variable interest rate that constitutes an eligible objective rate for a variable rate debt instrument that is a tax-exempt bond under § 1.1275–5(c)(5) ( i.e ., a qualified inflation rate or a qualified inverse floating rate); (b) interest on the bond is unconditionally payable at periodic intervals at least annually; (c) the final maturity date of the bond is no longer than the lesser of 40 years after the issue date of the bond or the latest date that is reasonably expected as of the issue date of the issue of which the bond is a part to be necessary to carry out the governmental purpose of the issue of which the bond is a part (with the 120 percent weighted average economic life of financed facilities test under Section 147(b) with respect to the issue of which the bond is a part being treated as a safe harbor for this purpose); and (d) the bond is subject to an optional tender right or a mandatory tender requirement which allows or requires a bondholder to tender the bond for purchase in one or more prescribed circumstances under the terms of the bond.

(2). Qualified Interest Rate Mode Change . In general, a “qualified interest rate mode change” is a change in the interest rate mode on a bond that is authorized under the terms of the bond upon 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 purchased and resold at a price equal to par upon conversion to a new interest rate mode, except only that, upon a conversion to an interest rate mode that

conversion options similar to tender option bonds which grant to the issuer or a conduit borrower an option to change the interest rate mode on the bonds from an auction rate mode to another short-term interest rate mode or to a fixed interest rate to maturity. At the time of a conversion to another interest rate mode, auction rate bonds typically are subject to a mandatory tender for purchase in a process similar to mandatory tenders on conversions of interest rate modes used with tender option bonds.

Questions have arisen regarding whether or to what extent auction rate bonds can be treated as qualified tender bonds for purposes of Notice 88–130. In addition, in light of recent guidance by the Securities and Exchanges Commission which authorizes issuers of tax-exempt bonds to bid on and acquire their own auction rate bonds in an auction in certain circumstances, additional questions have arisen regarding the tax consequences of such acquisitions in various circumstances and whether such acquisitions would result in a retirement or extinguishment of such bonds.