Internal Revenue Service
Revenue Ruling
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smRev. Rul. 79-79
1979-1 C.B. 74
Section 103
IRS Headnote
Interest; New York City bonds guaranteed by U.S. The proper date for determining whether bonds issued by the City of New York to city or state employee pension funds under the provisions of the New York City Loan Guarantee Act of 1978 are arbitrage bonds, within the meaning of section 103(c) of the Code, is the date the bonds are issued.
Full Text
Rev. Rul. 79-79
What is the proper date for determining whether municipal bonds are arbitrage bonds within the meaning of section 103(c) of the Internal Revenue Code of 1954?
FACTS
The City of New York proposes to issue bonds that will not be industrial development bonds within the meaning of section 103(b)(2)) of the Code. The payment of principal of and interest on the bonds will be guaranteed by the United States of America under the provisions of title I of the New York City Loan Guarantee Act of 1978, section 102, 92 Stat. 460 [Pub. L. 95-339, 1978-2 C.B. 353] (Act). The bonds will be sold to various city or state employee pension funds.
LAW AND ANALYSIS
Section 103(a)(1) of the Code provides that gross income does not include interest on obligations of a state or a political subdivision thereof.
Section 103(c)(1) of the Code provides that, with certain exceptions, an arbitrage bond is not treated as an obligation described in section 103(a)(1).
Section 103(c)(2) of the Code provides that the term "arbitrage bond" means any obligation all or a major portion (more than 15 percent) of the proceeds of which are reasonably expected at the time of issuance of such bond to be used directly or indirectly (A) to acquire securities or obligations that may be expected to produce a yield over the term of governmental issue that is materially higher than the yield on such issue; or (B) to replace funds that were used directly or indirectly to acquire securities or obligations described in (A).
Section 102(a) of the New York City Loan Guarantee Act of 1978 provides that the Secretary of the Treasury may guarantee the payment, in whole or in part, of interest, principal, or both, of the indebtedness of the city. Section 102(b) provides that the guarantee is effective only with respect to city indebtedness that is issued or to be issued to employee pension funds of the city or state, or any agency of the city or state, and shall terminate whenever such indebtedness is sold or otherwise disposed of by such fund.
Section 103(f) of the Code provides that any obligation the payment of principal or interest of which is guaranteed in whole or in part under title I of the Act shall, with respect to interest accrued during the period for which such guarantee is in effect, be treated as an obligation not described in section 103(a).
Section 1.103-13(a)(2)(i) of the proposed Income Tax Regulations published in the Federal Register on May 3, 1973 (38 FR 10944), as amended September 7, 1978 (43 FR 39825), provides that the determination whether an obligation is an arbitrage bond depends upon the reasonable expectation, as of the date of issue, regarding the amount and use of the proceeds of the issue.
In this case the City of New York proposes to issue bonds to city or state employee pensions funds in order that the guarantee by the United States Government under section 102(a) of the Act will apply. Because the payment of principal of or interest on the bonds is guaranteed, the bonds will not be considered obligations described in section 103(a)(1) of the Code, pursuant to section 103(f). However, if the employee pension funds sell or dispose of the bonds, the guarantee will terminate and section 103(a)(1) will apply unless the bonds are arbitrage bonds under section 103(c). Although the date of the sale or other disposition of the bonds by the employee pension funds would be the first time the interest on the bonds could be excludable from the gross income of the bondholders under section 103(a)(1), the determination of whether the bonds are arbitrage bonds is based on reasonable expectation at the date of issue as provided under section 103(c)(2) of the Code and section 1.103-13(a)(2)(i) of the proposed regulations.
HOLDING
The proper date for determining whether the City of New York bonds are arbitrage bonds within the meaning of section 103(c) of the Code is the date the bonds are issued.