proceeds of which are (i) reasonably expected to be used directly or indirectly to acquire certain obligations or securities (for purposes of this section referred to as "acquired obligations") which may reasonably be expected, at the time of issuance of such governmental obligations, to produce a yield over the term of the issue of such governmental obligations which is materially higher (taking into account any discount or premium) than the yield on such issue, or (ii) reasonably expected to be used to replace funds which were used directly or indirectly to acquire such acquired obligations. For rules as to industrial development bonds, see section 103(c).

(2) Definitions. (i) For purposes of this section, the term "governmental unit" means a State, the District of Columbia, a Territory, or a possession of the United States, or any political subdivision of any of the foregoing.

(ii) For purposes of this section, the term "securities" has the same meaning, as in section 165(g) (2) (A) and (B).

(3) Materially higher. For purposes of this section, the yield produced by acquired obligations is not "materially higher" than the yield produced by an issue of governmental obligations if it is reasonably expected, at the time of issue of such governmental obligations, that the adjusted yield (computed in accordance with subparagraphs (4) and (5) of this paragraph) to be produced by the acquired obligations will not exceed the adjusted yield (computed in accordance with subparagraphs (4) and (5) of this paragraph) to be produced by the issue of governmental obligations by more than one-half of 1 percentage point.

(4) Yield. (i) For purposes of this section, "yield" shall be computed using the "interest cost per annum" method in accordance with subdivision (ii) or (iii) of this subparagraph (as the case may be) or any other method satisfactory to the Commissioner which is consistent with generally accepted principles of computing yield. In the case of acquired obligations, the yield to be produced by such obligations shall be computed as if all acquired obligations comprised a single issue of obligations. Thus, for example, if the governmental unit acquires two blocks of Federal obligations, with dif

interest rates and

maturity

ferent periods for each block, the yield on such acquired obligations shall be computed as if one issue of obligations with different interest rates and maturity periods had been acquired. The maturity period of each acquired obligation shall be the period that the governmental unit reasonably expects to hold such obligation.

(ii) If all the governmental or acquired obligations of an issue have a single interest rate (expressed in dollars per $1,000 of face amount of bonds), yield shall be computed using the following 4 steps:

(a) Step (1). Compute the total number of bond years for the issue by multiplying the number of bonds (treating each $1,000 of face value as one bond for purposes of this computation) of each maturity by the length of the maturity period (expressed in years and fractions thereof) and then adding together the amounts determined for each maturity period.

(b) Step (2). Compute the total interest payable on the issue by multiplying the total number of bond years (as computed in step (1)) by the amount payable, expressed in dollars, as interest on each $1,000 of bonds for 1 year.

(c) Step (3). Compute the net interest in dollars for the issue by adding the amount, in dollars, of any discount to, or by subtracting the amount, in dollars, of any premium from, the total interest payable on the issue.

(d) Step (4). Compute yield by dividing the net interest by the product obtained by multiplying the total number of bond years for the issue by 10.

(iii) If governmental or acquired obligations of an issue have different interest rates (expressed in dollars per $1,000 of face amount of bonds), yield shall be computed using the following 4 steps:

(a) Step (1). Compute the total number of bond years for each group of bonds bearing the same interest rate (treating each $1,000 of face value as one bond for purposes of this computation) in the manner described in step 1 of subdivision (ii) of this subparagraph.

(b) Step (2). Compute the total interest payable on the issue by multiplying

66-056-72- 3

the total number of bond years for each group of bonds bearing the same interest rate (as computed in step (1)) by the amount payable, expressed in dollars, as interest on each $1,000 of bonds for 1 year, and then adding together the amounts determined for each group.

(c) Step (3). Compute net interest in the manner described in step (3) of subdivision (ii) of this subparagraph.

(d) Step (4). Compute the yield produced by the issue in the manner described in step (4) of subdivision (ii) of this subparagraph.

(iv) For purposes of this section, the same method of computing yield shall be used to compute the yield to be produced

by an issue of governmental obligations and to compute the yield to be produced by acquired obligations acquired with the proceeds of such issue of governmental obligations.

(v) The following example illustrates the provisions of this subparagraph:

Example. Assume an issue of $200,000 ($1,000 per bond) with a stated interest (expressed in dollars per bond) of $50 on bonds maturing in 1, 2, or 3 years, a stated interest of $60 on bonds maturing in 4, 5, 6, or 7 years and a stated interest of $70 on bonds maturing in 8, 9, or 10 years. Assume also that a price of $101 has been bid for the issue. The yield on the issue is determined in accordance with the table below:

(5) Adjusted yield. (i) For purposes of this section, "adjusted yield" shall be computed in accordance with subparagraph (4) of this paragraph, except that in the case of

(a) Acquired obligations, an amount equal to the sum of the administrative costs reasonably expected to be incurred in purchasing, carrying, and selling or redeeming such obligations shall be treated as a premium on the purchase price of such acquired obligations.

(b) An issue of governmental obligations, an amount equal to the sum of the

$77, 400 12,500

6.192

reasonably expected administrative costs of issuing, carrying, and repaying such issue of obligations shall be treated as a discount on the selling price of such issue of governmental obligations.

(ii) The provisions of subdivision (i) of this subparagraph may be illustrated by the following examples:

Example (1). State Z issues $15 million of obligations all of which will mature in 10 years. The obligations are sold at $1,000 each (par) to yield 6 percent interest. The adjusted yield produced by such issue of obligations will be determined as follows, assuming the following administrative expenses

Example (2). State Z uses the net proceeds of the issue of obligations described in Example (1) to acquire $14,922,000 of student's notes at par of $1,000 each under a student loan program. The students' notes will all mature in 10 years, and all have a stated interest of 72 percent. Expenses of the program include printing of forms ($5,000), financial advisors' fees ($11,000), counsel fees ($12,000), trustees' fees ($5,000), fees for the collecting agents and various banks which administer the loans ($100,000), advertising expenses ($10,000), credit reference checks ($20,000), and general office overhead ($5,000). Of the expenses listed in the preceding sentence, only those indicated on the following table constitute adjustments to yield in order to determine the adjusted yield to be produced by the students' notes: Purchasing costs:

Printing forms..

$5,000

(b) Rule with respect to certain governmental programs—(1) General rule. Subject to the limitations of subparagraph (3) of this paragraph, any obligations which are part of an issue of governmental obligations the proceeds of which are reasonably expected to be used to finance certain governmental programs (described in subparagraph (2) of this paragraph) are not arbitrage obligations.

(2) Governmental programs. A governmental program is described in this subparagraph if the program—

(i) Requires the acquisition of acquired obligations (such as, for example, student notes or home mortgage notes) in order to carry out the purposes of such program which obligations are, for purposes of this paragraph, referred to as "acquired program obligations";

(ii) Is reasonably expected to result (subsequent to the issuance of governmental obligations issued to finance such program) in the making of new or additional loans by the governmental unit or by others to a substantial number of persons representing the general public;

(iii) Requires that substantially all of the amounts received by the governmental unit with respect to acquired program obligations shall be used for one or more of the following purposes: to pay the principal or interests or otherwise to service the debt on the governmental obligations; to reimburse the governmental unit, or to pay, for administrative costs of issuing the gvernmental obligations; to reimburse une governmental unit, or to pay, for administrative and other costs and anticipated future losses directly related to the program financed by such governmental obligations; to make additional loans for the same general purposes specified in such program; or to redeem and retire the governmental obligations at the next earliest possible date of redemption; and

(iv) Requires that any person (or any related person, as defined in section 103 (c) (6) (C)) from whom the govern

mental unit may, under the program, acquire acquired program obligations shall not, pursuant to an arrangement, formal or informal, purchase the governmental obligations in an amount related to the amount of the acquired program obligations to be acquired from such person by the governmental unit. (3) Limitations. The provisions of subparagraph (1) of this paragraph shall apply only if it is reasonably expected that——

(i) A major portion of the proceeds of such issue of governmental obligations, including proceeds represented by repayments of principal and interest received by the governmental unit with respect to acquired program obligations, shall not be invested for more than a temporary period (within the meaning of section 103(d) (4) (A)), in acquired obligations (other than acquired program obligations) which produce materially higher yield than the yield produced over the term of the issue by such governmental obligations, and

a

(ii) (a) The adjusted yield (computed in accordance with paragraph (a) (4) and (5) of this section) to be produced by acquired program obligations shall not exceed the adjusted yield (computed in accordance with paragraph (a) (4) and (5) of this section) to be produced by such issue of governmental obligations by more than 12 percentage points, or

(b) Where the difference in the adjusted yields described in subdivision (ii) (a) of this subparagraph is expected to exceed 12 percentage points, the amounts to be obtained as a result of the difference in such adjusted yields shall not exceed the amount necessary to pay expenses (including losses resulting from bad debts) reasonably expected to be incurred as a direct result of administering the program to be financed with the proceeds of such issue of governmental obligations, to the extent that such amounts are not payable with funds appropriated from other sources.

(4) Examples. The following examples illustrate governmental programs described in subparagraph (2) of this paragraph:

Example (1). State A issues obligations the proceeds of which are to be used to purchase certain home mortgage notes from commercial banks. The purpose of the governmental program is to encourage the construction of low income residential housing by creating

a secondary market for mortgage notes and thereby increasing the availability of mortgage money for low income housing. The legislation provides that the adjusted yield produced by the mortgage notes to be acquired will not exceed the adjusted yield produced by such issue of obligations by more than 12 percentage points. Amounts received as interest and principal payments on the mortgage notes are to be used for one or more of the following purposes: (1) To service the debt on the governmental obligations, (2) to retire such obligations at their earliest possible date of redemption, (3) to purchase additional mortgage notes. The governmental program is one which is described in subparagraph (2) of this paragraph and the governmental obligations are not arbitrage bonds.

Example (2). State B issues obligations the proceeds of which are to be used to make loans directly to students and to purchase from commercial banks promissory notes made by students as the result of loans made to them by such banks. The legislation authorizing the student loan program provides that the purpose of the program is to enable financially disadvantaged students to continue their studies. The legislation also provides that purchases will be made from banks only where such banks agree that an amount at least equal to the purchase price will be devoted to new or additional student loans. It is reasonably expected that the difference in adjusted yields between the issue of governmental obligations by State B and the students' notes will be 134 percentage points. It is also reasonably expected that the amount necessary to pay the expenses (other than expenses taken into account in computing adjusted yield) enumerated in subparagraph (3) (ii) (b) of this paragraph, directly incurred as a result of administering State B's student loan program, such as, for example, losses resulting from bad debts, insurance costs, bookkeeping expenses, advertising expenses, credit reference checks, appraisals, title searches, general office overhead, service fees for collecting agents and various banks which administer the loans, and salaries of employees not paid from other sources, will not require a difference in adjusted yields in excess of 12 percentage points. The governmental program is one which is described in subparagraph (2) of this paragraph. Since, however, the difference in adjusted yields produced by the students' notes and the issue of State B obligations is reasonably expected to exceed 12 percentage points, and since State B cannot show that 14 percentage points is necessary to cover such expenses, the provisions of subparagraph (1) of this paragraph shall not apply to the issue of State B obligations. If, however, State B reasonably expected that 14 percentage points would be necessary to cover such expenses, the provisions of subparagraph (1) of this paragraph

would apply and the governmental obligations would not be arbitrage bonds.

Example (3). Authority C issues obligations the proceeds of which are to be used to purchase land to be sold to veterans. The governmental unit will receive purchase-money mortgage notes secured by mortgages on the land from the veterans in return for such land. The purpose of the program is to enable veterans to acquire land at reduced cost. The adjusted yield produced by the mortgage notes is not reasonably expected to exceed the adjusted yield produced by the issue of obligations issued by Authority C by more than 12 percentage points. Amounts received as interest and principal payments on the mortgage notes are to be used for one or more of the following purposes: (1) To pay the administrative costs directly related to the program, (2) to service the debt on the governmental obligations, (3) to retire such governmental obligations at their earliest possible call date, (4) to purchase additional land to be sold to veterans. The governmental program is one which is described in subparagraph (2) of this paragraph and the governmental obligations are not arbitrage bonds.

(e) Effective date. The provisions of this section will apply with respect to obligations issued after October 9, 1969, and before final regulations are promulgated.

[T.D. 7072, 35 F.R. 17406, Nov. 13, 1970; 35 F.R. 18524, Dec. 5, 1970]

§ 13.6 Accumulation trusts; 65 day election; "first taxable year in which income is accumulated."

(a) Election regarding distributions in first 65 days of taxable year—(1) In general. With respect to taxable years beginning after December 31, 1968, the fiduciary of a trust may elect under section 663 (b) to treat any distribution or any portion of any distribution to a beneficiary within the first 65 days following the taxable year as an amount which was paid or credited on the last day of such taxable year. An election is effective only with respect to the taxable year for which the election is made. An election shall be made for each taxable year for which the treatment is desired.

(2) Effect of election. If an election is made with respect to a taxable year of a trust, this section shall apply only to those amounts which are properly paid or credited within the first 65 days following such year and which are designated by the fiduciary in his election.

Any amount considered under section 663 (b) as having been distributed in the preceding taxable year shall be so treated for all purposes. For example, in determining the beneficiary's tax liability, such amount shall be considered as having been received by the beneficiary in his taxable year in which or with which the last day of the preceding taxable year of the trust ends.

(3) Manner and time of election; revocations. The election shall be made in a statement attached to the return of the trust for the taxable year for which the election is made. The election shall be made not later than the time prescribed by law for filing the return for such taxable year (including extensions thereof). An election shall become irrevocable after the last day prescribed for making the election.

(4) Elections under prior law. Elections made pursuant to section 663 (b) prior to its amendment by section 331(b) of the Tax Reform Act of 1969 (83 Stat. 598), which, under prior law, were irrevocable for the taxable year for which the election was made and all subsequent years, are not effective for taxable years beginning after December 31, 1968. In the case of a trust for which an election was made under prior law, the fiduciary shall make the election for each taxable year beginning after December 31, 1968, for which the treatment provided by section 663 (b) is desired.

(b) Definition of “first taxable year in which income is accumulated." Section 668(a) (3) imposes a partial tax as determined under section 669 in the case of a beneficiary of a trust which is not required to distribute all of its income currently. Section 668 (a) further provides that a trust shall not be considered to be a trust which is not required to distribute all of its income currently for any taxable year prior to the first taxable year in which income is accumulated. For purposes of section 668(a), the phrase "the first taxable year in which income is accumulated" does not include any taxable year prior to the first taxable year beginning after December 31, 1968. See section 643 (b) and § 1.643 (b) -1 for the definition of the term "income".

[T.D. 7025, 35 F.R. 3031, Feb. 14, 1970, as amended by T.D. 7029, 35 F.R. 3995, Mar. 13, 1970]