A requirement imposed under the Code with respect to Tax-Exempt Bonds to pay to the Internal Revenue Service (IRS) an amount equal to the excess of earnings received from investment of Tax-Exempt Bond proceeds over what  would have been earned if those amounts had been invested at the Bond Yield (i.e., the Arbitrage on those Tax-Exempt Bond proceeds), calculated using a future value methodology pursuant to Treasury Regulations promulgated under the Code. (In the case of a Conduit Financing, the Bond Documents often shift the responsibility of making Rebate payments to the Conduit Borrower.) 

The Rebate rules provide that even if Bond proceeds may be invested at a materially higher Yield above the Bond Yield, all permitted earnings above the Bond Yield, with limited exceptions, must be paid to the federal government. Although quite different from what we think of as a “rebate” in common parlance (someone returning a portion of the money you have paid to them), this payment to the federal government is called a “Rebate” payment, and the rules surrounding the requirement are referred to as the Rebate rules.  Rebate must be calculated and paid at least every five years and at the retirement of the Bond Issue. There are also certain exceptions to the Rebate requirement, including the so-called “spending exceptions” and an exception for small Issuers.

Spending Exceptions to Rebate

The Rebate requirements do not apply to Bonds which meet one of three spending exceptions: (i) the 6-month exception, (ii) the 18-month exception or (iii) the 2-year exception. Even if the Bond Issue meets one of these exceptions, the amounts held in a Reasonably Required Reserve or Replacement Fund are still subject to Rebate, and a Debt Service Reserve Fund is still subject to Rebate unless the Debt Service Reserve Fund constitutes a Bona Fide Debt Service Fund and certain other exceptions are met. The 6-month exception is applicable to all Bond Issues and provides an exemption from Rebate for Bond Issues in which all Gross Proceeds are expended within 6 months following issuance. The 18-month exception is applicable to Bond Issues financing new money projects and has 6-month (at least 15% spent) and 12-month (at least 60% spent) interim spending milestones. The 2-year exception is applicable to Governmental Bond Issues and Qualified 501(c)(3) Bond Issues for construction in which all “available construction proceeds” are expended within two years following issuance and has 6-month (at least 10% spent), 12-month (at least 45% spent) and 18-month (at least 75% spent) interim spending milestones.

Other Exceptions

Governmental Bonds or Governmental Purpose Bonds for Issuers who reasonably expect to issue less than $5 million during the calendar year are exempt from Rebate (but are still subject to Yield Restriction after any applicable Temporary Period).  The $5 million limit is increased to $15 million if the additional $10 million is spent for the construction of public school facilities.  Further, amounts earned on Bona Fide Debt Service Funds are exempt from Rebate if the total earnings on such funds do not exceed $100,000 per year.  Earnings on Bona Fide Debt Service Funds for Fixed Rate Governmental Bonds or Governmental Purpose Bonds are ignored whether such earnings exceed $100,000. Issues with average annual Debt Service that does not exceed $2.5 million may also be treated as satisfying the $100,000 exception.

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See Also


Profit from differences in markets. All tax-advantaged bonds are subject in one way or another to the arbitrage requirements, which are contained in Section 148 of the Code and the Treasury Regulations that go along with it.


As computed under the Code provisions applicable to bonds, the internal rate of return that causes the present value of the payments of principal and interest (and, in certain cases, certain other payments) on an issue of bonds to equal the issue price of the bonds.

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