SECTION 2. BACKGROUND

Section 103(a) of the Internal Revenue Code of 1986 provides that interest on a State or local bond is excludable from gross income. Section 103(b)(2) of the 1986 Code provides, however, that interest on an arbitrage bond is not excludable from gross income. Section 148(a) of the 1986 Code generally provides that a bond is an arbitrage bond if it is part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly to acquire higher yielding investments. A bond is also an arbitrage bond if the issuer intentionally uses the proceeds for this purpose.

Section 1.148–5(b)(2) of the Income Tax Regulations provides that, for purposes of the yield restriction rules of § 148(a) of the 1986 Code, yield is computed separately for each class of investments. For this purpose, in determining the yield on a separate class of investments, the yield on each individ

ual investment within the class is blended with the yield on other individual investments within the class, whether or not held concurrently, by treating those investments as a single investment. Yield restricted nonpurpose investments are treated as a separate class of investments.

Section 1.148–5(c) provides that certain payments may be made to the United States to reduce yield on an investment for purposes of § 148(a) of the 1986 Code. Section 1.148–5T(c)(3)(ii) generally provides, however, that yield reduction payments may not be applied to investments allocable to gross proceeds of an advance refunding issue.

Section 1.148–10(g) provides that, notwithstanding any specific provision of §§ 1.148–1 through 1.148–11, the Commissioner may take any action, if the Commissioner finds that good faith or other similar circumstances so warrant, consistent with the purposes of § 148 of the 1986 Code.

1995–2 C.B. 417