Rev. Rul. 81-56
1981-1 C.B. 53, 1981-8 I.R.B. 7.
Internal Revenue Service
Revenue Ruling
INDUSTRIAL DEVELOPMENT BONDS; EXEMPT SMALL ISSUE; PURCHASE OF GOODWILL
Published: February 23, 1981
26 CFR 1.103-10: Exemption for certain small issues of industrial development bonds
(Also Section 61; 1.61-7.)
Industrial development bonds; exempt small issue; purchase of goodwill. The purchase with the proceeds of industrial development bonds of goodwill as part of the assets of a business is not an acquisition of property that qualifies under section 103(b)(6)(A) of the Code. If a nonexempt person purchases goodwill with its own funds together with facilities it will use in connection with its existing facilities in the same city that were financed the previous year by industrial development bonds, the purchase is a capital expenditure within the meaning of section 103(b)(6)(D).
ISSUES
(1) Is the purchase of goodwill an acquisition of property that qualifies under section 103(b)(6)(A) of the Internal Revenue Code?
(2) Is the purchase of goodwill a capital expenditure within the meaning of section 103(b)(6)(D) of the Code for purposes of determining if the exempt small issue limitation of $10,000,000 has been exceeded?
FACTS
Situation 1. City M, an incorporated municipality, proposes to issue industrial development bonds in the amount of $1,000,000 to finance the acquisition of the assets of an established and active business enterprise to be used by a nonexempt person. M proposes to treat the bonds as a $1,000,000 exempt small issue under section 103(b)(6)(A) of the Code. The business activity is currently owned and operated by an individual taxpayer as a sole proprietorship. The business assets to be acquired consist of land, building, and equipment totaling $850,000 and goodwill of $150,000.
Situation 2. In 1979, city O, an incorporated municipality, issued industrial development bonds in the amount of $9,000,000 and financed the acquisition of manufacturing facilities located in O for use by a nonexempt person. O made the election provided in section 103(b)(6)(D) of the Code to treat the bonds as an exempt small issue of $10,000,000 or less. On the date the bonds were issued there were no prior outstanding small issues and no capital expenditures had been made that were required to be taken into account in determining whether the aggregate face amount of the bonds exceeded $10,000,000.
During 1980, the nonexempt person used its own funds and acquired an active business enterprise located in O for a purchase price of $1,200,000 ($1,000,000 for land, building, and equipment and $200,000 for goodwill). The newly acquired facilities are operated in connection with the nonexempt person's regular activities in O.
LAW AND ANALYSIS
Section 103(a)(1) of the Code provides that gross income does not include interest on the obligations of a state or political subdivision of the state.
Section 103(b)(1) of the Code provides that, except as otherwise provided in section 103(b), any industrial development bond shall be treated as an obligation that is not described in section 103(a)(1).
Section 103(b)(6)(A) of the Code provides that section 103(b)(1) shall not apply to any obligation issued as part of an issue the aggregate authorized face amount of which is $1,000,000 or less and substantially all of the proceeds of which are to be used for the acquisition, construction, reconstruction, or improvement of land or property of a character subject to the allowance for depreciation, or to redeem part or all of a prior issue that was issued for such purposes.
Section 103(b)(6)(D) of the Code provides that, at the election of the issuer, section 103(b)(1) shall not apply to obligations issued in an aggregate face amount of $10,000,000 or less and substantially all of the proceeds of which are to be used for the acquisition or construction of land or property of a character subject to the allowance for depreciation. For purposes of determining the aggregate face amount of such bond issue, there must be taken into account the face amount of the bonds to be issued, the outstanding face amount of any prior exempt small issues, and the aggregate amount of capital expenditures with respect to certain facilities.
Section 1.103-10(b)(2)(ii) of the Income Tax Regulations provides that an expenditure (regardless of how paid, whether in cash, notes, or stock in a taxable or nontaxable transaction) is a section 103(c)(6)(D) (redesignated as section 103(b)(6)(D)) capital expenditure if:
(a) The capital expenditure was financed other than out of the proceeds of issues taken into account.
(b) The capital expenditures were paid or incurred during the 6-year period that begins 3 years before the date of issuance of the issue and ends 3 years after such date.
(c) The principal user of the facility in connection with which the property resulting from the capital expenditures is used and the principal user of the facility financed by the proceeds of the issue in question is the same person or are two or more related persons.
(d) Both facilities referred to in (c) were located in the same incorporated municipality or in the same county (outside of the incorporated municipality in such county), and
(e) The capital expenditures were properly chargeable to the capital account of any person or state or local governmental unit (whether or not such person is the principal user of the facility or a related person).
Section 1.103-10(b)(2)(i)(b) of the regulations provides that the loss of the tax exemption for interest on an exempt small issue of governmental obligations shall begin on the date of the capital expenditure that causes the obligations to exceed the exempt small issue limitation.
Section 1.167(a)-3 of the regulations provides that no deduction for depreciation is allowable with respect to goodwill.
Situation 1. In order to qualify as a $1,000,000 exempt small issue under section 103(b)(6)(A) of the Code, substantially all (90 percent or more) of the bond proceeds must be used for the acquisition of land or depreciable property. Goodwill does not qualify as land and is not subject to the allowance for depreciation. See section 1.167(a)-3 of the regulations.
Situation 2. The nonexempt person's purchase of the business enterprise for $1,200,000 included goodwill of $200,000. The goodwill was (1) financed other than out of bond proceeds, (2) paid for during the three-year period following the issuance of the bonds, (3) used by the nonexempt person in connection with the facility financed by bonds issued by O, (4) attributable to a business enterprise located in the same incorporated municipality as the facility financed by bond proceeds, and (5) chargeable to the capital account of the nonexempt person. Thus, the purchase of goodwill by the nonexempt person satisfies the requirements set forth in section 1.103-10(b)(2)(ii) of the regulations.
HOLDING
Situation 1. The purchase of goodwill by city M will not be an acquisition of property that qualifies under section 103(b)(6)(A) of the Code. Because less than substantially all (90 percent or more) of the bond proceeds ($850,000/ $1,000,000 equals 85 percent) will be used for land or property subject to the allowance for depreciation, the bonds will not qualify as a $1,000,000 exempt small issue under section 103(b)(6)(A) and the interest on the bonds will not be excludable from gross income under section 103(a)(1).
Situation 2. The purchase of goodwill by the nonexempt person is a capital expenditure within the meaning of section 103(b)(6)(D) of the Code and section 1.103-10(b)(2)(ii) of the regulations. Because the aggregate face amount of the bonds ($9,000,000 plus $1,200,000 equals $10,200,000) exceeded the $10,000,000 limitation for an exempt small issue, the exception provisions of section 103(b)(6)(D) do not apply and the interest on the bonds is not excludable from gross income under section 103(a)(1) beginning on the date of the capital expenditure.
Rev. Rul. 81-56, 1981-1 C.B. 53, 1981-8 I.R.B. 7.