Rev. Rul. 83-8
1983-1 C.B. 25, 1983-8 I.R.B. 7.
Internal Revenue Service
Revenue Ruling
INDUSTRIAL DEVELOPMENT BONDS; EXEMPT SMALL ISSUE, REFUNDING ISSUE
Published: January 10, 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, refunding issue. The interest on a $1,000,000 exempt small issue of industrial development bonds described in section 103(b)(6)(A) of the Code will be excludable from gross income if (1) substantially all of the bond proceeds will be used to redeem a portion of an outstanding issue of bonds that originally qualified, but no longer qualifies, as a $10,000,000 exempt small issue described in section 103(b)(6)(D), (2) substantially all the proceeds of the bonds to be redeemed were used to acquire land and depreciable property, and (3) both issues will be issued by the same issuer.
ISSUE
Will the interest on a $1,000,000 issue of industrial development bonds be excludable from gross income under section 103(a)(1) of the Internal Revenue Code if all the bond proceeds will be used to redeem a portion of an outstanding issue of industrial development bonds the interest on which is includible in gross income?
FACTS
On January 2, 1980, city CI issued industrial development bonds in the face amount of $8,000,000 to finance the acquisition by corporation X of manufacturing facilities located in CI. Substantially all (90 percent or more) of the bond proceeds were used to purchase land and depreciable property. CI properly elected to treat the bonds as an exempt small issue of $10,000,000 or less as described in section 103(b)(6)(D) of the Code. On March 2, 1981, X made capital expenditures of $3,000,000 within CI to expand the
manufacturing facilities. At that time, the interest on the bonds became includible in the gross income of the bondholders because the exempt small issue limitation of $10,000,000 had been exceeded.
CI now proposes to issue industrial development bonds in the face amount of $1,000,000 and will treat the bonds as an exempt small issue described in section 103(b)(6)(A) of the Code. The bond proceeds will be used to refund $1,000,000 of CI's above described taxable obligations.
The bonds will not be "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 described in section 103(a)(1).
Section 103(b)(6)(A) of the Code provides that section 103(b)(1) will not apply to any obligation issued as part of an issue of which the aggregate authorized face amount is $1,000,000 or less, and if substantially all (90 percent or more) of the proceeds of the issue will be used (i) to acquire land or property of a character subject to the allowance for depreciation, or (ii) to redeem part or all of a prior issue that was issued for purposes described in (i). In the determination of the aggregate face amount of a $1,000,000 exempt small issue, both the face amount of the bonds to be issued and the outstanding face amount of certain prior exempt small issues must be taken into account. See section 103(b)(6)(B).
Section 103(b)(6)(D) of the Code provides that, at the election of the issuer, the aggregate face amount of an exempt small issue may be as great as $10,000,000; however, in the determination of the aggregate face amount of such an issue, not only the face amount of the bonds to be issued and the outstanding face amount of certain prior exempt small issues must be taken into account, but also the aggregate amount of capital expenditures for certain facilities.
Section 1.103-10(c)(1) of the Income Tax Regulations provides that section 103(c)(1) of the Code (redesignated as section 103(b)(1)) will not apply to any debt obligations issued by a state or local governmental unit as part of an issue the aggregate authorized face amount of which is $1,000,000 or less if substantially all of the proceeds are to be used: (i) to redeem part or all of a prior issue substantially all of the proceeds of which were used to acquire, construct, reconstruct, or improve land or property of a character subject to the allowance for depreciation, or (ii) to redeem part or all of a prior exempt small refunding issue.
Section 1.103-10(c)(2) of the regulations provides that section 103(c)(1) of the Code (redesignated as section 103(b)(1)) will not apply to any debt obligations issued by a governmental unit as part of an issue that is $5,000,000 or less ($10,000,000 or less after December 31, 1978) if the condition of section 103(c)(6)(H) (redesignated section 103(b)(6)(H)) is met and if substantially all of the proceeds are to be used: (i) to redeem part or all of one or more prior exempt small issues, or (ii) to redeem part or all of one or more prior exempt small refunding issues. The condition of section 103(b)(6)(H) is that an election by the issuer of the $5,000,000 ($10,000,000 after December 31, 1978) exemption in lieu of the $1,000,000 limit for a refunding issue may be made only if each prior issue being redeemed is an issue that qualified either for the $1,000,000 exemption, or by reason of an election under section 103(c)(6)(D) (redesignated as section 103(b)(6)(D)), for the $5,000,000 exemption ($10,000,000 after December 31, 1978).
In situation 3 of Rev. Rul. 77-317, 1977-2 C.B. 32, a political subdivision of a state proposes to issue two separate industrial development bond issues totaling $4,800,000. The proceeds of the issue of $800,000 will be used to redeem an indebtedness of A, an owner of a factory. The proceeds of the second later issue of $4,000,000 will be loaned to B to acquire A's factory. The revenue ruling holds that the interest on the $4,000,000 issue will be excludable from gross income because the bonds will qualify for the exception provisions of section 103(b)(6)(D) of the Code as an exempt small issue. The interest on the $800,000 issue will not be excludable from gross income because the issue will not qualify as an issue to redeem a prior issue within the meaning of section 103(b)(6)(A)(ii). The rationale for the holding is as follows: "The prior issues that may be redeemed under section 103(b)(6)(A)(ii) are those of the same issuer that issued the subsequent issue, or an issue of a legal predecessor of the subsequent issuer, since the section refers only to refunding obligations. See Conf. Rept. No. 1533, 90th Cong., 2nd Sess., 1968-2 C.B. 801, 810."
In this case CI proposes to issue a $1,000,000 exempt small issue described in section 103(b)(6)(A) of the Code and to use the proceeds to redeem a part of its earlier issue of $8,000,000 that qualified at issuance as an exempt small issue of $10,000,000 or less described in section 103(b)(6)(D). The $8,000,000 issue has ceased to qualify as an obligation described in section 103(a)(1) because capital expenditures caused the aggregate face amount of the bonds to exceed the exempt small issue limitation. CI's proposed refunding bonds will satisfy the requirements under section 103(b)(6)(A) and section 1.103-10(c)(1)(i) of the regulations because substantially all of the proceeds will be used to redeem part of a prior issue substantially all the proceeds of which were used to acquire land and depreciable property. The qualifying requirements for a $1,000,000 exempt small issue of refunding bonds are different from those of a $10,000,000 exempt small issue of refunding bonds. The proceeds of a $10,000,000 issue must be used to redeem a prior exempt small issue. See section 1.103-10(c)(2)(i). In addition, both the prior issue to be refunded and the proposed refunding issue will be issued by CI, as required by Rev. Rul. 77-317. Therefore, the proposed refunding bonds will qualify under section 103(b)(6)(A)(ii) of the Code as an exempt small issue of $1,000,000 or less.
HOLDING
The interest on the bonds will be excludable from gross income under section 103(a)(1) of the Code.
Rev. Rul. 83-8, 1983-1 C.B. 25, 1983-8 I.R.B. 7.