Reg. § 1.1397E-1 Qualified zone academy bonds.
(a) In general
(1) Overview In general, a qualified zone academy bond (QZAB or QZABs) is a taxable bond issued by a state or local government the proceeds of which are used to improve certain eligible public schools. An eligible taxpayer that holds a QZAB generally is allowed annual Federal income tax credits in lieu of periodic interest payments. These credits compensate the eligible taxpayer for lending money to the issuer and function as payments of interest on the bond. Accordingly, this section generally treats the allowance of a credit as if it were a payment of interest on the bond. This section also provides other rules for QZABs, including rules governing the credit rate, the private business contribution requirement, the maximum term, use and expenditure of proceeds, remedial actions, eligible issuers, arbitrage investment restrictions, and information reporting.
(2) Certain definitions
(i) In general For purposes of this section, except as otherwise provided in this section, the following definitions apply: the definitions set forth in this section; the definitions used for general tax-exempt bond purposes in ; and the definitions used for purposes of the arbitrage investment restrictions on tax-exempt bonds in .
(ii) Applicable definition of proceeds
(A) Use and expenditure provisions Except as provided in and of this section, for purposes of all applicable requirements regarding use and expenditure of proceeds of QZABs under section and this section, “proceeds” means “sale proceeds,” as defined in , plus “investment proceeds,” as defined in .
(B) Private business contribution requirement For purposes of the private business contribution requirement of section , “proceeds” means “sale proceeds,” as defined in .
(C) Arbitrage investment restrictions For purposes of the scope of application of the arbitrage investment restrictions under section and of this section, “proceeds” generally means gross proceeds, as defined in . In addition, in applying the arbitrage investment restrictions under of this section and under section , the various applicable definitions of the various types of proceeds of tax-exempt bonds under shall apply.
(b) Credit rate The Secretary shall determine monthly (or more often as deemed necessary by the Secretary) the credit rate the Secretary estimates will generally permit the issuance of a qualified zone academy bond without discount and without interest cost to the issuer. The manner for ascertaining the credit rate for a qualified zone academy bond as determined by the Secretary shall be set forth in procedures, notices, forms, or instructions prescribed by the Commissioner.
(c) Private business contribution requirement
(1) Reasonable discount rate To determine the present value (as of the issue date) of qualified contributions from private entities under section , the issuer must use a reasonable discount rate. The credit rate determined under of this section is a reasonable discount rate.
(2) Definition of private entities For purposes of section , the term private entities includes any person (as defined in section ) other than the United States, a State or local government, or any agency or instrumentality thereof or related party with respect thereto. To determine whether a person is related to the United States or a State or local government under this , rules similar to those for determining whether a person is a related party under shall apply (treating the United States as a governmental unit for purposes of ).
(3) Qualified contribution For purposes of section , the term qualified contribution means any contribution (of a type and quality acceptable to the eligible local education agency) of any property or service described in section , (ii), (iii), (iv) or (v). In addition, cash received with respect to a qualified zone academy from a private entity (other than cash received indirectly from a person that is not a private entity as part of a plan to avoid the requirements of section ) constitutes a qualified contribution if it is to be used to purchase any property or service described in section , (ii), (iii), (iv) or (v). Services of employees of the eligible local education agency do not constitute qualified contributions.
(d) Maximum term The maximum term for a QZAB is determined under section by using a discount rate equal to 110 percent of the long-term adjusted applicable Federal rate (AFR), compounded semi-annually, for the month in which the bond is sold. The Internal Revenue Service publishes this figure each month in a revenue ruling that is published in the Internal Revenue Bulletin. See . A bond is sold on the sale date, as defined in , which is the first day on which there is a binding contract in writing for the sale or exchange of the bond.
(e) Tax credit
(1) Eligible taxpayer An eligible taxpayer (within the meaning of section ) that holds a qualified zone academy bond on a credit allowance date is allowed a tax credit against the Federal income tax imposed on the taxpayer for the taxable year that includes the credit allowance date. The amount of the credit is equal to the product of the credit rate and the outstanding principal amount of the bond on the credit allowance date. The credit is subject to a limitation based on the eligible taxpayer's income tax liability. See section .
(2) Ineligible taxpayer A taxpayer that is not an eligible taxpayer is not allowed a credit.
(f) Treatment of the allowance of the credit as a payment of interest
(1) General rule The holder of a qualified zone academy bond must treat the bond as if it pays qualified stated interest (within the meaning of ) on each credit allowance date. The amount of the deemed payment of interest on each credit allowance date is equal to the product of the credit rate and the outstanding principal amount of the bond on that date. Thus, for example, if the holder uses an accrual method of accounting, the holder must accrue as interest income the amount of the credit over the one-year accrual period that ends on the credit allowance date.
(2) Adjustment if the holder cannot use the credit to offset a tax liability If a holder holds a qualified zone academy bond on the credit allowance date but cannot use all or a portion of the credit to reduce its income tax liability (for example, because the holder is not an eligible taxpayer or because the limitation in section applies), the holder is allowed a deduction for the taxable year that includes the credit allowance date (or, at the option of the holder, the next succeeding taxable year). The amount of the deduction is equal to the amount of the unused credit deemed paid on the credit allowance date.
(g) Not a tax-exempt obligation A qualified zone academy bond is not an obligation the interest on which is excluded from gross income under section .
(h) Use of proceeds
(1) In general Section provides that a bond issued as part of an issue is a QZAB only if, among other requirements, at least 95 percent of the proceeds of the issue are to be used for a qualified purpose with respect to a qualified zone academy established by an eligible local education agency (as defined in section ), and the issue meets the requirements of section and (g). Section defines qualified purpose, with respect to any qualified zone academy, as rehabilitating or repairing the public school facility in which such academy is established, providing equipment for use at such academy, developing course materials for education to be provided at such academy, and training teachers and other school personnel in such academy. Section defines qualified zone academy as any public school (or academic program within a public school) that is established by and operated under the supervision of an eligible local education agency to provide education or training below the postsecondary level and that meets the requirements of section , (ii), (iii) and (iv).
(2) Use of proceeds requirements An issue meets the requirements of sections (d)(1)(A) and (f) only if—
(i) The issuer reasonably expects, as of the issue date of the issue, that—
(A) At least 95 percent of the proceeds from the sale of the issue are to be spent for qualified purposes with respect to qualified zone academies within the 5-year period beginning on the issue date of the QZAB;
(B) A binding commitment with a third party to spend at least 10 percent of the proceeds from the sale of the issue will be incurred within the 6-month period beginning on the issue date of the QZAB;
(C) At least 95 percent of the proceeds from the sale of the issue will be spent for qualified purposes with respect to a qualified zone academy with due diligence (with due diligence measured by the reasonableness standard under ); and
(D) At least 95 percent of the proceeds of the issue will be used for qualified purposes with respect to a qualified zone academy for the entire term of the issue (without regard to any redemption provision); and
(ii) Except as otherwise provided in of this section, at least 95 percent of the proceeds of the issue are actually used for qualified purposes with respect to a qualified academy for the entire term of the issue (without regard to any redemption provision).
(3) Extension of 5-year period The Commissioner may extend the period described in of this section if the issuer, prior to the end of such period, submits a private ruling request, and establishes to the satisfaction of the Commissioner that—
(i) The failure to satisfy the 5-year spending requirement is due to reasonable cause; and
(ii) The expenditure of at least 95 percent of the proceeds from the sale of the issue for a qualified purpose with respect to a qualified zone academy will continue to proceed with due diligence.
(4) Unspent proceeds For purposes of and of this section, during the period described in of this section, including any extension under of this section, unspent proceeds are treated as used for a qualified purpose with respect to a qualified zone academy if the issuer reasonably expects to proceed with due diligence to spend those proceeds for a qualified purpose with respect to a qualified zone academy during that period.
(5) Proceeds spent for rehabilitation, repair or equipment
(i) In general Under section the term qualified purpose with respect to any qualified zone academy includes rehabilitating or repairing the public school facility in which such academy is established. For this purpose, in determining whether proceeds are spent for rehabilitation, rules similar to those under section (other than sections and ) shall apply. Under section the term qualified purpose also includes providing equipment for use at such academy. If proceeds of an issue are spent for a purpose described in section or (B) with respect to a qualified zone academy, then those proceeds are treated as used for a qualified purpose with respect to the academy during any period after such expenditure that—
(A) The property financed with those proceeds is used for the purposes of the academy; and
(B) The academy maintains its status as a qualified zone academy under section .
(ii) Retirement from service The retirement from service of financed property due to normal wear or obsolescence does not cause the property to fail to be used for a qualified purpose with respect to a qualified zone academy.
(6) Proceeds spent to develop course materials or train teachers Section and (D) provides that the term qualified purpose with respect to any qualified zone academy includes developing course materials for education to be provided at such academy, and training teachers and other school personnel in such academy. If proceeds of an issue are spent for a purpose described in section or (D) with respect to a qualified zone academy, then those proceeds are treated as used for a qualified purpose with respect to the academy during any period after such expenditure.
(7) Special rule for determining status as qualified zone academy Section provides that a public school (or academic program within a public school) is a qualified zone academy only if, among other requirements, the public school is located in an empowerment zone or enterprise community (as defined in section ), or there is a reasonable expectation (as of the issue date of the issue) that at least 35 percent of the students attending the school or participating in the program (as the case may be) will be eligible for free or reduced-cost lunches under the school lunch program established under the Richard B. Russell National School Lunch Act. For purposes of determining whether an issue complies with section —
(i) A public school is treated as located in an empowerment zone or enterprise community for the entire term of the issue if the public school is located in an empowerment zone or enterprise community on the issue date of the issue; and
(ii) The determination of whether there is a reasonable expectation (as of the issue date of the issue) that at least 35 percent of the students attending the school or participating in the program (as the case may be) will be eligible for free or reduced-cost lunches under the school lunch program established under the Richard B. Russell National School Lunch Act is based on expectations regarding the one-year period following the issue date.
(8) Remedial actions
(i) General rule If less than 95 percent of the proceeds of an issue are properly used (as determined under of this section), the issue will be treated as meeting the requirements of section if the issue met the requirements of of this section and a remedial action is taken under or of this section.
(ii) Redemption or defeasance
(A) In general A remedial action is taken under this if the requirements of and of this section are met.
(B) Retirement of nonqualified bonds
(1) In general The requirements of this are met if—
(i) All of the nonqualified bonds of the issue (as determined under ) are redeemed within 90 days after the date on which the failure to properly use proceeds occurs; or
(ii) To the extent proceeds of the issue that have been actually spent for a qualified purpose with respect to a qualified zone academy, if any nonqualified bonds of the issue are not redeemed within 90 days after the date on which the failure to properly use such proceeds occurs (the unredeemed nonqualified bonds), a defeasance escrow is established for the unredeemed nonqualified bonds within 90 days after the date on which the failure to properly use proceeds occurs.
(2) Special rule for dispositions for cash If the failure to properly use proceeds occurs because of a disposition of financed property described in section or (B) and the consideration for the disposition is exclusively cash, the requirements of this are met if all of the disposition proceeds (as defined in of this section) are used within 90 days after the date of the disposition to redeem, or establish a defeasance escrow for, the nonqualified bonds (as determined under ).
(3) Definition of defeasance escrow For purposes of this section, a defeasance escrow is an irrevocable escrow established to retire nonqualified bonds on the earliest call date after the date on which the failure to properly use proceeds occurs in an amount that is sufficient to retire nonqualified bonds on that call date. At least 90 percent of the weighted average amount in a defeasance escrow must be invested in investments (as defined in ), except that no amount in a defeasance escrow may be invested in any investment the obligor (or any person that is a related party with respect to the obligor within the meaning of ) of which is a user of proceeds of the bonds. All purchases or sales of an investment in a defeasance escrow must be made at the fair market value of the investment within the meaning of .
(C) Additional rules
(1) Limitation on source of funding Proceeds of an issue of QZABs (other than unspent proceeds of the issue for which the failure to properly use proceeds occurs) must not be used to redeem or defease nonqualified bonds under of this section.
(2) Rebate requirement The issuer must pay to the United States, at the same time and in the same manner as rebate amounts are required to be paid under (or at such other time or in such other manner as the Commissioner may prescribe), any investment earnings on amounts in a defeasance escrow established under of this section that are in excess of the yield on the issue of QZABs with respect to which the defeasance escrow was established. For this purpose, the first computation period begins on the date on which the defeasance escrow is established.
(3) Notice of defeasance The issuer must provide written notice to the Commissioner, at the place designated in , of the establishment of the defeasance escrow within 90 days of the date the defeasance escrow is established.
(D) When a failure to properly use proceeds occurs
(1) Unspent proceeds For unspent proceeds, a failure to properly use proceeds occurs on the earliest of—
(i) The first date on which the public school (or academic program within the public school) fails to constitute a qualified zone academy;
(ii) The first date on which the issuer fails to have a reasonable expectation to proceed with due diligence to spend at least 95 percent of the proceeds of the issue for a qualified purpose with respect to a qualified zone academy; or
(iii) The last day of the period described in of this section, including any extension, if less than 95 percent of the proceeds of the issue are actually spent for a qualified purpose with respect to a qualified zone academy.
(2) Proceeds spent for rehabilitation, repair or equipment For proceeds that have been spent for a purpose described in section or (B) with respect to a qualified zone academy, a failure to properly use proceeds occurs on the earlier of—
(i) The first date on which the public school (or academic program within the public school) fails to constitute a qualified zone academy; and
(ii) The first date on which an action is taken that causes the issuer to fail actually to use at least 95 percent of the proceeds of the issue for a qualified purpose with respect to a qualified zone academy.
(3) Proceeds spent for course materials or training If proceeds have been spent for a purpose described in section or (D) with respect to a qualified zone academy, no event subsequent to such expenditure shall constitute a failure to properly use such proceeds.
(iii) Alternative use of disposition proceeds A remedial action is taken under this if all of the requirements of through of this section are met—
(A) The failure to properly use proceeds (as determined under of this section) is a disposition of financed property described in section or (B) and the consideration for the disposition is exclusively cash;
(B) The issuer reasonably expects as of the date of the disposition that—
(1) All of the disposition proceeds will be spent within the two-year period beginning with the date of the disposition for a qualified purpose with respect to a qualified zone academy; or
(2) To the extent not expected to be so spent, the disposition proceeds will be used within 90 days after the date of the disposition to redeem or defease bonds in a manner that meets the requirements of of this section;
(C) The disposition proceeds are treated as proceeds for purposes of section ; and
(D) If all of the disposition proceeds are not actually used in the manner described in of this section, the remainder of such amounts are used within 90 days after the end of the period described in of this section for a remedial action that meets the requirements of of this section.
(iv) Definition of disposition proceeds and allocation among multiple funding sources For purposes of this , disposition proceeds means disposition proceeds, as defined in , plus amounts derived from investing disposition proceeds. If property has been financed with an issue of QZABs and one or more other funding sources, any disposition proceeds from that property are allocated to the issue under the principles of .
(9) Payment of principal, interest or redemption price
(i) In general Except as provided in and of this section, the use of proceeds of a bond to pay principal, interest, or redemption price of the bond or another bond is not a qualified purpose within the meaning of section .
(ii) Exception for certain eligible reimbursements of interim refinancings The use of proceeds of a bond (the refinancing bond) to pay principal, interest, or redemption price of another bond (the prior bond) is a qualified purpose within the meaning of section to the extent that—
(A) The prior bond was not a QZAB (and, in the case of a series of refinancings, no earlier bond in the series was a QZAB);
(B) The proceeds of the prior bond (or the original bond in the case of a series of refinancings, as applicable) were spent for a qualified purpose under section with respect to a qualified zone academy (the original expenditure); and
(C) The issuer makes a valid reimbursement allocation to allocate the proceeds of the refinancing bond to the payment of the original expenditure (the reimbursement allocation), which allocation satisfies the requirements for reimbursements under of this section. For purposes of applying the rules for reimbursement, a refinancing bond which otherwise meets the requirements of this is eligible for reimbursement and is not treated as a disqualified refunding under .
(iii) Reissuance of a QZAB For purposes of determining whether the establishing of a defeasance escrow under of this section results in an exchange under , the QZAB is treated as a tax-exempt bond under .
(10) Reimbursement An expenditure for a qualified purpose may be reimbursed with proceeds of a QZAB. For this purpose, rules similar to those on reimbursement of expenditures in and shall apply. In applying these reimbursement rules, expenditures eligible for reimbursement under shall be deemed to mean any expenditure for a qualified purpose under section .
(i) Arbitrage investment restrictions
(1) In general Under section and this , and except as otherwise provided in this , the arbitrage investment restrictions and rebate requirements under section and through , inclusive, and the exceptions to those restrictions, apply broadly to gross proceeds of QZABs issued under section to the same extent and in the same manner as they apply to gross proceeds of tax-exempt state or local governmental bonds. For this purpose, references in those sections to tax-exempt bonds generally shall be deemed to refer to QZABs and, to the extent that any particular arbitrage restriction depends on whether bonds are private activity bonds under section , the determination of whether QZABs are private activity bonds shall be based on the general definition of private activity bonds under section . In applying section and the regulations under that section to QZABs, the modifications set forth in through of this section shall apply.
(2) 5-year temporary period exception to arbitrage yield restriction If an issue of QZABs meets the requirements of section and of this section, then the proceeds of the issue of QZABs are treated as qualifying for a 5-year temporary period exception to arbitrage yield restriction under beginning on the issue date of the issue.
(3) Disregard QZAB credit in QZAB yield for arbitrage purposes In determining the yield on an issue of QZABs for arbitrage purposes under , the QZAB credit allowed under section is disregarded.
(4) Non-AMT tax-exempt bond investment exception inapplicable The exception to arbitrage yield restriction for investments of gross proceeds of tax-exempt bonds in specified tax-exempt bond investments not subject to section (relating to an exception to the definition of “investment property” for specified tax-exempt bonds) and (relating to a corresponding exception to arbitrage yield limitations) is inapplicable.
(5) Application of small issuer exception to the arbitrage rebate requirement Except as otherwise provided in of this section, for purposes of the small issuer exception to the arbitrage rebate requirement under section and , QZABs that are actually issued or reasonably expected to be issued by the QZAB issuer (and applicable entities aggregated under section ) within a calendar year are taken into account in measuring the applicable size limitation.
(6) Certain defeasance escrow earnings With respect to a defeasance escrow established in a remedial action for an issue of QZABs that meets the special rebate requirement under of this section, the QZAB issuer is treated as ineligible for the small issuer exception to arbitrage rebate under section and of this section and compliance with that special rebate requirement is treated as satisfying applicable arbitrage investment restrictions under section for that defeasance escrow.
(j) Information reporting requirement Under section and this , issuers of QZABs are required to submit information reporting returns to the IRS similar to the information reporting returns required to be submitted to the IRS under section for tax-exempt state or local governmental bonds at the same time and in the same manner as those reports are required to be submitted to the IRS on such forms as shall be prescribed by the Commissioner for such purpose.
(k) State or local government
(1) In general For purposes of section , the term State or local government means a State or political subdivision as defined for purposes of section .
(2) On behalf of issuer A qualified zone academy bond may be issued on behalf of a State or local government under rules similar to those for determining whether a bond issued on behalf of a State or political subdivision constitutes an obligation of that State or political subdivision for purposes of section .
(l) Cross-references See section and the regulations thereunder for rules relating to amortizable bond premium. See for the seller's treatment of a bond sold between interest payment dates (credit allowance dates) and for the buyer's treatment of a bond purchased between interest payment dates (credit allowance dates).
(m) Effective/applicability dates
(1) In general Except as otherwise provided in this , this section applies to bonds issued under section that are sold on or after September 14, 2007.
(2) Special effective dates
(i) Effective dates for paragraphs (h)(2), (h)(3), (h)(4), (i), and (j) of this section in general , , , , and of this section apply to bonds issued under section pursuant to allocations of the national qualified zone academy bond volume cap authority for calendar years after 2005 and sold on or after September 14, 2007.
(ii) Permissive retroactive application
(A) In general Except as otherwise provided in this , issuers and taxpayers may apply this section in whole, but not in part, to bonds issued under section that are sold before September 14, 2007.
(B) Special rule for certain provisions For purposes of the permissive retroactive application rule in of this section, , , , , and of this section need not be applied to any bonds issued under section to which those provisions do not otherwise apply under the general effective date provisions for those provisions in of this section.
(C) Definition of proceeds Issuers and taxpayers may apply of this section, without regard to the definition of proceeds in of this section, to bonds issued under section that are sold before September 14, 2007.
(D) Bonds issued before July 1, 1999 and of this section may not be applied to bonds issued under section that are issued before July 1, 1999.
(3) Scope of reliance for bonds issued under sections 54A and 54E Except to the extent inconsistent with the successor statutory provisions for QZABs in sections 54A and 54E or applicable public administrative or regulatory guidance under those provisions and except as otherwise provided in this , issuers and taxpayers may apply these regulations to QZABs issued under sections 54A and 54E that are sold after October 3, 2008. In the case of QZABs that are issued under sections 54A and 54E for which the issuer makes an irrevocable election under section to receive payments with respect to credits under section , issuers and taxpayers may not apply the remedial action provisions under of this section.
[T.D. 8755, 63 FR 673, Jan. 7, 1998; 63 FR 8528, Feb. 19, 1998, as amended by T.D. 8826, 64 FR 35574, July 1, 1999. Redesignated and amended by T.D. 8903, 65 FR 57733, Sept. 26, 2000; T.D. 9339, 72 FR 38774, July 16, 2007;T.D. 9495, 75 FR 44904, July 30, 2010; T.D. 9495, 75 FR 52267, Aug. 25, 2010]