SECTION 7. 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 such a conversion. The Bonds are qualified tender bonds under § 3.2 of this 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.

Example 3 . Impact of Authorized Changes in In- terest Rate Modes and Associated Mandatory Tenders and Effect of Serialization .

(i) 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 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 right 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 a qualified tender right, 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 tender right 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% directly resulted from 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 through 150 as a result of the change in credit enhancement.

(ii) Assume the same facts as paragraph (i) above except that the Issuer also amended the terms of the Bonds to modify a term Bond which had a prescribed mandatory sinking fund redemption schedule with alternative Bonds with “serial” maturities instead of the sinking fund redemption schedule. This “serialization” of the term Bond does not directly result from the qualified interest rate mode change. Subject to the particular terms of the Bonds, the serialization of the term Bond generally would be a modification under § 1.1001–3 which would be required to be analyzed for significance under the change in yield rule in § 1.1001–3(e)(2) and the change in the timing of payments rule in § 1.1001–3(e)(3).

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

2008–15 I.R.B. 746 April 14, 2008

and therefore was not a qualified tender right 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.

Example 5 . Operation of the 180-Day Temporary Rule for Qualified Tender Rights .

(i) On July 1, 2007, a municipality (the “Issuer”) issued $1 million in tax-exempt bonds that bear interest initially at a variable rate demand rate and that mature in 40 years (the “Bonds”). The interest rate on the Bonds resets every 7 days at the minimum interest rate necessary to remarket the Bonds at par. The Bonds have seven-day tender options exercisable by the holders while the Bonds are in the variable rate demand interest rate mode. The Bonds give the Issuer an option to convert the interest rate on the Bonds to other interest rate modes. The Bonds have a mandatory tender requirement upon an interest rate mode conversion. The Bonds are secured by a third-party liquidity facility in the form of a letter of credit (the “Liquidity Facility”) from a bank (the “Bank”). The Bonds are further secured by a third-party guarantee in the form of a bond insurance policy from a bond insurer (the “Bond Insurer”). An investment bank serves as a remarketing agent (“Remarketing Agent”) for the Issuer with respect to the Bonds. The terms of the remarketing arrangement require the Remarketing Agent to use at least its best efforts to remarket tendered Bonds. On May 1, 2008, the Issuer exercises its option to convert the interest rate on the Bonds to a fixed interest rate to maturity and the Bonds are subject to mandatory tender by the Bondholders. The Bonds are qualified tender bonds which have a qualified tender right and a qualified interest rate mode change within the meaning of § 3.2 of this notice. During the 180-day period after the date of purchase of the bonds pursuant to the qualified tender right, as a result of difficult market conditions and despite best efforts required pursuant to the terms of the Bonds, the Issuer and the Remarketing Agent are unsuccessful in remarketing the Bonds. The particular terms of the Liquidity Facility require that the qualified tender right be funded by the Bank under the Liquidity Facility, but that the Bank not hold the Bonds upon a draw on the Liquidity Facility. Instead, the Bank merely receives a pledge of the Bonds as collateral for the draw on the Liquidity Facility and the Issuer holds the Bonds upon a draw on the Liquidity Facility. During this 180-day period, the Bonds are treated as outstanding under the operating rules for qualified tender rights in § 3.2(3)(b) even if the Bonds are held by or on behalf of the Issuer. Thus, during this 180-day period, the Issuer may hold the Bonds under the terms of the Bonds without causing a retirement of the Bonds. In addition, recognizing that the Bonds are treated as outstanding during this 180-day period, the Issuer may refund the Bonds with proceeds from refunding bonds during this period or resell the bonds to a third party.

(ii) Assume the same facts as in paragraph (i), but further assume that the Issuer retains the Bonds beyond the 180-day permitted holding period for a governmental issuer under § 3.2(3)(b) of this notice.

The Bonds are treated as retired as of the end of the 180 ^th day from and after the date of the purchase of the Bonds pursuant to the exercise of the qualified tender right. Thus, the count of the 180-day permitted holding period for the Issuer starts on the date of the purchase pursuant to the qualified tender right (here, starting May 1, 2008) and ends at the end of the 180 ^th

day from and after the date of purchase (here, ending at the end of the day on October 27, 2008).

(iii) Assume the same facts as in paragraph (i), but further assume that the terms of the Liquidity Facility provide that the Bank will hold the Bonds upon a draw on the Liquidity Facility, rather than merely receive a pledge of the Bonds as collateral while the Issuer or its agent holds the Bonds. Here, since a third-party liquidity facility provider is not treated as a purchaser by or on behalf of a governmental issuer under the general rules in § 3.1 of this notice, the Bank may hold the Bonds during and beyond the 180-day period after the date of the purchase pursuant to the qualified tender right without causing a retirement of the Bonds.

(iv) Assume the same facts as in paragraph (i), but further assume that the Issuer holds the Bonds for 179 days after purchase of the Bonds pursuant to the exercise of a qualified tender right while using best efforts under the terms of the Bonds to remarket the Bonds, and then sells the Bonds to the Bank pursuant to the Liquidity Facility. This transaction complies with the operating rules for qualified tender rights in § 3.2(3)(b) of this notice and does not result in a retirement of the Bonds.