Rev. Rul. 83-18

1983-1 C.B. 28, 1983-4 I.R.B. 11.

                       Internal Revenue Service
                                 Revenue Ruling

    INDUSTRIAL DEVELOPMENT BONDS;  EXEMPT SMALL ISSUE;  CAPITAL EXPENDITURES

                          Published: January 24, 1983

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;  capital expenditures.  A capital expenditure by a nonexempt person for equipment that was installed in a county manufacturing facility and was transferred to the nonexempt person's facility in a city more than 3 years after the issuance of an exempt small issue of industrial development bonds to finance the city facility is not a capital expenditure with respect to the city facility even though the expenditure was made within 3 years of the date of the bond issue.  Therefore, the aggregate face amount of the bonds will not exceed the exempt small issue limitation under section 103(b)(6)(D) of the Code and the interest on the bonds will be excludable from gross income under section 103(a)(1).  Rev. Rul. 78-347 distinguished.

ISSUE

  Will an "exempt small issue" of industrial development bonds described in section 103(b)(6)(D) of the Internal Revenue Code exceed the exempt small issue limitation of $10,000,000 under the circumstances described below?

FACTS

  Corporation X, which is not an exempt person within the meaning of section 103(b)(3) of the Code, decided that it would establish a part of its manufacturing operation in city CI of state ST.  X located an equipped factory building in CI that was available for a purchase price of $9,000,000.  X requested CI to issue industrial development bonds in the amount of $9,000,000 to provide financing for the purchase of the facility.

  CI issued industrial development bonds in the amount of $9,000,000 and loaned the bond proceeds to X for the purchase of the facility.  Before the issuance of the bonds, CI filed a statement with the Internal Revenue Service electing to treat the bonds as an exempt small issue of $10,000,000 or less under the provisions of section 103(b)(6)(D) of the Code.  X had not owned or operated any facilities in CI before the acquisition of the land.  The bonds are not arbitrage bonds within the meaning of section 103(c)(2).

  X also owned and operated a manufacturing facility in county CY of ST.  Within the 3-year period after CI issued its bonds, X purchased equipment for $1,500,000 and installed it in the facility in CY.  X intended to use the equipment in the facility located in CY during the equipment's entire useful life.   However, more than 3 years after CI issued its bonds, X decided to expand its facility in CI.  X transferred the $1,500,000 of equipment located in CY to CI, installed the equipment in the CI facility, and began using it in the operation of the facility.

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 its political subdivisions.

  Section 103(b)(1) of the Code provides that, except as otherwise provided in section 103(b), any industrial development bond will be treated as an obligation that is not described in section 103(a)(1).

  Section 103(b)(6)(D) of the Code provides that, at the election of the issuer, section 103(b)(1) will not apply to any obligation issued as part of an issue if the aggregate face amount of the issue is $10,000,000 or less and if substantially all (90 percent or more) of the proceeds of the issue are to be used to acquire or construct land or property of a character subject to the allowance for depreciation.  To determine the aggregate face amount of a bond issue, the face amount of the bonds to be issued, the outstanding face amount of certain prior exempt small issues, and the aggregate amount of capital expenditures for certain facilities must all be taken into account.

  Section 1.103-10(b)(2)(ii) of the Income Tax Regulations provides that an expenditure 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 that 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 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 municipalities in the 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 the person is the principal user of the facility or a related person).

  In Example (12) of section 1.103-10(f) of the regulations, an industrial corporation transferred machinery from its factory in one city to its factory in another city.  The factory in the city to which the machinery was transferred was financed by proceeds from an exempt small issue of industrial development bonds described in section 103(b)(6)(D) of the Code.  Example (12) concludes that the transfer of the machinery within 3 years after the issuance of the bonds will not be a section 103(b)(6)(D) capital expenditure at the new location because the expenditures for the machinery were incurred more than 3 years before the issuance of the exempt small issue.  If the expenditures for the machinery had been incurred less than 3 years before the issuance of the bonds, they would be section 103(b)(6)(D) capital expenditures.

  In Rev. Rul. 78-347, 1978-2 C.B. 101, a manufacturing facility located in county M was financed with proceeds from an exempt small issue of $4,000,000. Within 3 years after the issuance of the bonds, X, the principal user of the facility, ordered $2,000,000 of equipment for the facility from Y, a manufacturer located outside M.  X will not make any payment and will not take delivery of the equipment until more than 3 years after the bonds were issued. However, within the 3-year period, Y did pay or incur $1,350,000 of the $1,800,000 cost of manufacturing the equipment.  The expenditure was chargeable to the capital account of Y.  Rev. Rul. 78-347 concludes that the expenditure by Y was made with respect to X's bond-financed facility located in M.  X is the principal user of that facility of which the equipment will be a part. Because the capital expenditure was for the ultimate benefit of X, X was considered to have incurred the capital expenditure concurrently with Y. Therefore, a portion ($1,500,000) of X's purchase price was taken into account as a capital expenditure.  When the capital expenditure was aggregated with the face amount of the bonds, the aggregate amount exceeded the exempt small issue limitation of $5,000,000 ($10,000,000 after December 31, 1978) and the interest on the bonds became taxable.

  The exempt small issue provisions under section 103(b)(6)(D) of the Code were enacted by Congress to place a definite limit on the total dollar amount that may be expended by or with respect to a nonexempt beneficiary of an exempt small issue of industrial development bonds for facilities in a particular political subdivision during a 6-year period (3 years before the date of the bond issue and 3 years after such date).

  In this case, X made capital expenditures of $1,500,000 for equipment within 3 years after the issue date of CI's bonds.  However, X did not intend to use the equipment in its facility in CI.  X actually installed the equipment in its facility in CY and used the equipment there during the 3-year period after CI issued the bonds.  It was only as a result of a later decision to expand the facility in CI that the equipment was transferred for use in X's facility in CI.  Because X had no intention of using the equipment in its facility in CI when the equipment was purchased, did not initially install the equipment in its facility in CI during the 3 years after the issuance of CI's bonds, and did not transfer the equipment to its facility in CI during such 3 year period, X's cost of the equipment did not increase the total dollar amount expended for the facility in CI during the 6-year period.  Therefore, X's capital expenditure is not considered made with respect to the facility in CI, and such capital expenditure is not taken into account in determining the aggregate face amount of CI's bonds.  X's capital expenditure was made with respect to the facility in CY.

  The facts in this revenue ruling are distinguishable from those in Example  (12) of section 1.103-10(f) of the regulations.  In Example (12), the machinery was transferred to a factory in a city during the 3-year period following the issuance of the bonds, while in this revenue ruling, the equipment was transferred after the 3-year period following the issuance of the bonds.  In addition, the facts in this revenue ruling are distinguishable from the facts in Rev. Rul. 78-347.  In Rev. Rul. 78-347, the

beneficiary of an exempt small issue of industrial development bonds ordered equipment with the intention of using the equipment in the bond-financed facility in the county where the facility is located, but the beneficiary would not pay for the equipment or take delivery until after the 3-year period following the issuance of the bonds.  In this revenue ruling, X did not intend to use the equipment in its facility in CI at the time the equipment was purchased.

HOLDING

  The aggregate face amount of the bonds ($9,000,000 face amount) to be issued by CI will not exceed the exempt small issue limitation of $10,000,000 under section 103(b)(6)(D) of the Code.  Therefore, the interest on the bonds will be excludable from gross income under section 103(a)(1).

EFFECT ON OTHER REVENUE RULINGS

  Rev. Rul. 78-347 is distinguished.

Rev. Rul. 83-18, 1983-1 C.B. 28, 1983-4 I.R.B. 11.