Hewitt staff warns council about IRS arbitrage rules when planning bond borrowing

City finance staff told the City Council on July 21 that municipal tax-exempt borrowing can trigger Internal Revenue Service arbitrage rules requiring rebate calculations if bond proceeds are not spent according to federal timing rules. Staff summarized arbitrage basics and how they affect municipal borrowing: municipalities issuing tax‑exempt bonds must ensure bond proceeds are spent for public projects in a timely way and that earnings on temporarily invested proceeds do not materially exceed the bond yield. If earnings exceed the allowed yield, the excess — an arbitrage rebate — generally must be returned to the U.S. Treasury. The staff memo cited Internal Revenue Code section 148 as the governing provision that covers yield restriction and arbitrage rebate calculations. The staff presentation noted the practical trigger the city must watch: if proceeds are not spent within the first 36 months after issuance, the city may need to perform an arbitrage calculation or seek IRS guidance. "If you don't have money spent within the first 36 months of an issue, you're potentially going to have to do either an arbitrage calculation" a staff presenter said. Staff also said the city received an IRS letter in a prior issuance (cited from January 2014 on a 2010 issuance) and completed the arbitrage calculation, which showed the city's earnings did not exceed the allowed yield in that instance. Finance staff cautioned that underwriting for new debt now asks how much of borrowed proceeds the city expects to have spent at 12, 24 and 36 months; habitual delays could be considered in future underwriting and affect the city's borrowing profile. Council members asked procedural questions about how often such audits occur and whether delays outside the city's control — pandemic-related delays, supply-chain constraints, permitting or extended engineering timelines — could cause a problem. Staff answered that such external delays do occur and that being conservative about the amount borrowed relative to projects the city can contract and spend promptly reduces risk. No formal action was taken; staff recommended council match any borrowing amount to a prioritized project list and realistic spending schedule so the city avoids unnecessary arbitrage risk and potential underwriting consequences.