Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 78-59

1978-1 C.B. 30

Sec. 103

IRS Headnote

Industrial development bonds; exempt small issue; capital expenditures. The costs of storage units and handling equipment manufactured by a wholly owned subsidiary and distributed to its parent in another county as an in-kind dividend for use in operation of a warehouse that the county in which the parent is located will construct for sale to the parent and finance by issuing industrial development bonds are capital expenditures for purposes of the $5,000,000 exempt small issue limitation. The costs of the items distributed to the parent are determined in accordance with the subsidiary's method of inventory valuation for products of such type.

Full Text

Rev. Rul. 78-59

Advice has been requested whether, under the circumstances described below, the cost of certain equipment must be taken into account in determining if the $5,000,000 small issue limitation of section 103(b)(6)(D) of the Internal Revenue Code of 1954 will be exceeded.

X corporation manufactures certain industrial production machinery in county M. Y corporation, a wholly-owned subsidiary of X located in another county, manufactures certain storage and handling equipment for industrial customers.

M proposes to issue industrial development bonds as described in section 103(b)(2) of the Code for the purpose of constructing a warehouse in M for sale to X under an installment sale agreement. M will elect to apply the provisions of section 103(b)(6)(D) in order that the bonds will qualify as an exempt small issue of $5,000,000 or less. Prior to commencement of construction of the warehouse, M executed a resolution whereby it agreed to issue the bonds to finance the warehouse.

The storage units and handling equipment necessary for the operation of the warehouse will be manufactured by Y. Y will transfer title to these items to X, its sole shareholder, as an in-kind dividend distribution. The manufacture and distribution of the items will occur within three years of the date the bonds will be issued by M. The amount of the distribution will equal the costs of the items to Y determined under its method of valuing inventories, which is an acceptable method under section 471 of the Code.

Although section 103(a)(1) of the Code provides, in part, that gross income does not include interest on the obligations of a political subdivision, section 103(b)(1) provides, in part, that industrial development bonds shall not be treated as obligations of a political subdivision. Therefore, the general rule in regard to industrial development bonds is that gross income does include the interest on industrial development bonds. However, section 103(b) provides certain exceptions to this general rule.

One of these exceptions is provided in section 103(b)(6)(D) of the Code whereby at the election of the issuer a small issue exemption is available to an issuance of $5,000,000 or less of industrial development bonds. However, if the election is made, the aggregate face amount of the bond issue will be determined, for purposes of determining if the $5,000,000 limit has been exceeded, by taking into account any capital expenditures made with respect to facilities of the type described in section 103(b)(6)(E) and paid or incurred during the six-year period beginning three years before and ending three years after the issuance of the bonds in question and financed otherwise than out of the proceeds of a prior exempt issue already being taken into account.

The facilities described in section 103(b)(6)(E) of the Code are those in which the principal user is the same person as the principal user of the facilities financed by the bonds in question or a person related thereto, provided that both facilities are located in the same incorporated municipality or located in the same county (but not in any incorporated municipality).

Section 1.103-10(b)(2)(ii) of the Income Tax Regulations provides, in part, that an expenditure is a section 103(c)(6)(D) (redesignated as section 103(b)(6)(D) by the Tax Reform Act of 1976, section 1901(a), 1976-3 (Vol. 1) C.B. 240, 242) capital expenditure if the capital expenditures were properly chargeable to the capital account of any person. With respect to obligations issued on or after August 8, 1972, determinations under the preceding sentence shall be made by including any expenditure which may, under any rule or election under the Code, be treated as a capital expenditure (whether or not such expenditure is so treated).

The expenditures of Y for the storage units and handling equipment to be installed in the warehouse will be capital expenditures made with respect to the bond financed facility and paid or incurred within three years of the bond issuance by a party related to the principal user of the facilities financed by the bonds.

Accordingly, these expenditures must be taken into account for purposes of determining if the $5,000,000 small issue limitation of section 103(b)(6)(D) of the Code has been exceeded. See example (12) of section 1.103-10(f) of the regulations. The amount to be taken into account will be equal to Y's cost for the items, determined in accord with Y's method of inventory valuation for products of that type.