Rev. Rul. 83-78

1983-1 C.B. 24.

                       Internal Revenue Service
                                 Revenue Ruling

     INDUSTRIAL DEVELOPMENT BONDS;  EXEMPT FACILITIES;  SOME OTHER SIMILAR
                                OFFICIAL ACTION

                            Published: May 16, 1983

26 CFR 1.103-8: Interest on bonds to finance certain exempt facilities

(Also Section 61; 1.61-7.)

  Industrial development bonds;  exempt facilities;  some other similar official action.  The adoption by a city of a resolution to issue bonds to finance construction of an exempt facility described in section 103(c)(4) of the Code followed by the adoption of a supplemental resolution to issue the bonds in a larger face amount because of a construction cost overrun are considered some other similar official action taken before construction commenced as required by section 1.103-8(a)(5)(iii) of the regulations. Therefore, the bonds qualify as obligations to provide exempt facilities described in section 103(b)(4) and the interest on the bonds is excludable from gross income.

ISSUE

  Do industrial development bonds qualify as obligations issued to provide an exempt facility described in section 103(b)(4) of the Internal Revenue Code 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, owns land located in city CI.  X decided to construct on the land an exempt facility described in section 103(b)(4).  The cost of the facility was estimated to be $20,000,000.  X planned to use temporary financing to construct the facility but requested that CI issue industrial development bonds to provide long-term permanent financing for the completed facility.

  On May 1, 1980, the governing body of CI adopted a resolution evidencing the intent of CI to issue industrial development bonds to provide permanent financing for X's facility.  The resolution contained a reasonably specific description of the facility, the general terms of the bonds, and the approximate face amount of the bonds of $20,000,000.

  Construction of the facility was commenced by X on June 2, 1980.  Thereafter, satisfactory progress was made toward completion of the facility.  However, on July 1, 1981, X became aware that the total cost paid or incurred for construction of the facility had exceeded the original estimate of $20,000,000 by $1,000,000.  The revised cost of the completed facility was estimated to be $25,000,000.  The increase in cost was attributed to inflation and X 's decision to incorporate into the facility further safety features.  The nature, character, and purpose of the facility had not changed in any material way, and the facility's capacity was not increased.

  On July 15, 1981, the governing body of CI adopted a supplemental resolution to increase the amount of the industrial development bonds to be issued to $25,000,000 in order to finance the increased cost of the facility.

  The facility was completed on January 5, 1982.  CI issued the bonds on the same date and loaned the bond proceeds to X. X immediately used all of the bond proceeds to retire the temporary financing.  X placed the facility in service on January 18, 1982.

  The bonds are not arbitrage bonds within the meaning of section 103(c)(2) of the Code.

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 an obligation described in section 103(a)(1).

  Section 103(b)(4) of the Code provides that section 103(b)(1) will not apply to industrial development bonds if substantially all of the bond proceeds will be used to provide certain exempt facilities.

  The "substantially all" test in section 103(b)(4) of the Code is satisfied if 90 percent or more of the proceeds of an issue of governmental obligations are used to provide an exempt facility. Section 1.103-8(a)(1)(i) of the Income Tax Regulations.

  Section 1.103-8(a)(5)(i) of the regulations provides, in part, that to qualify under section 103(b)(4) of the Code and section 1.103-8 as an exempt facility, the facility must be one described in subdivision (iii) of subparagraph (5) if the construction, reconstruction, or acquisition of the facility commences on or after September 2, 1972.

  Section 1.103-8(a)(5)(iii) of the regulations provides that if the original use of a facility commences (or acquisition of a facility occurs) on or after the date of issue of obligations issued to provide such facility, a bond resolution with respect to such obligations must have been adopted or some other similar official action toward the issuance of such obligations must have been taken by the issuer prior to the commencement of construction or acquisition of such facility in order for the facility to qualify as an exempt facility under section 103(b)(4) of the Code.

  The general purpose of section 1.103-8(a)(5) of the regulations is to prevent the proceeds of an issue of obligations described in section 103(a)(1) of the Code from being used to refinance a facility.  Such refinancing would result in providing working capital to the owner or users of the facility rather than providing the facility as required by section 103(b)(4).  Rev. Rul. 79-321, 1979-2 C.B. 37.

  In this case, CI adopted a resolution evidencing an intent to issue bonds to provide permanent financing for X's facility when it was completed.  The resolution was adopted before X commenced construction of the facility.  The subsequent determination that the facility had exceeded the original estimated cost prompted CI to adopt a supplemental resolution to issue bonds in a larger face amount.  However, the increased cost of the facility was caused by inflation and certain additional safety considerations and not by a change in the nature, character, purpose, or capacity of the facility.  The facility completed at a larger estimated cost remained substantially the same facility as the one originally considered in CI's first resolution. Therefore, the first resolution, together with the supplemental resolution, which was adopted within a reasonable time after the discovery of the cost overrun, are considered to be some other similar official action taken before the construction of the facility was commenced.

  Under the above circumstances, the facility is described in section 1.103-8(a)(5)(iii) of the regulations because some other similar official action was taken before the construction of the facility was commenced, and the facility was placed in service after the issuance of the bonds.

HOLDING

  The industrial development bonds issued by CI qualify as obligations to provide exempt facilities described in section 103(b)(4) of the Code. Therefore, the interest on the bonds is excludable from gross income under section 103(a)(1).

Rev. Rul. 83-78, 1983-1 C.B. 24.