Rebate Rule
IRC Section 148(f) describes the arbitrage rebate rule. Even if an issuer of bonds follows all of the yield restriction rules, the bonds may still be arbitrage bonds if excess profits are not returned to the Treasury. Arbitrage profits are equal to any amount earned in profits from investing proceeds that is above the coupon rate of the bond issue. For an issue to be tax-exempt, any arbitrage profits must be paid to the U.S. in five-year installments.
The IRC requires that earnings on gross proceeds from any tax-exempt municipal bonds that are in excess of the prescribed amount be surrendered to the Internal Revenue Service. If this amount is not paid to the U.S., the municipal bonds become arbitrage bonds, subject to federal taxation.
Example: A town issues mu