[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.103-10]
[Page 381-389]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.103-10 Exemption for certain small issues of industrial development bonds.
(a) In general. Section 103(b)(6) applies to certain industrial
development bond issues (referred to in this section as ``exempt small
issues'') and bonds issued to refund certain issues (referred to in this
section as ``exempt small refunding issues''). If an issue is an exempt
small issue or an exempt small refunding issue, then under the
requirements of section 103(b)(6) and this section the interest paid on
the debt obligations is not includable in gross income, and the
obligations are treated as obligations described in section 103(a)(1)
and Sec. 1.103-1, even though such obligations are industrial
development bonds as defined in section 103(b)(2) and Sec. 1.103-7.
However, interest on an obligation of such an issue is includable in
gross income if the obligation is held by a substantial user of the
financed facilities or a related person (as described in section
103(b)(7) and Sec. 1.103-11). Section 103(b)(6) only becomes applicable
where the bond issue meets both the trade or business and the security
interest tests so that the obligations are industrial development bonds
within the meaning of section 103(b)(2). For bonds issued before January
1, 1979, in taxable years ending before such date, and for capital
expenditures made before January 1, 1979, with respect to such bonds,
paragraphs (b), (c), and (d) of this section shall be applied by
substituting $5 million for $10 million.
(b) Small issue exemption--(1) $1 million or less. Section
103(b)(6)(A) provides that section 103(b)(1) shall not apply to any debt
obligation issued by a State or local governmental unit as part of an
issue where--
(i) The aggregate authorized face amount of such issue (determined
by aggregating the outstanding face amount of any prior exempt small
issues described in paragraph (d) of this section and the face amount of
the issue of obligations in question) is $1 million or less; and
(ii) Substantially all of the proceeds of such issue is to be used
for the acquisition, construction, reconstruction, or improvement of
land or property of a character subject to the allowance for
depreciation under section 167. Proceeds which are loaned to a borrower
for use as working capital or to finance inventory are not used in the
manner described in the preceding sentence. Whether substantially all of
the proceeds of an issue of governmental obligations are used in such
manner is determined consistently with the rules for exempt facilities
in Sec. 1.103-8(a)(1)(i). Any obligation which is an industrial
development bond within the meaning of section 103(b)(2) and which
satisfies the $1 million small issue exemption requirements is an exempt
small issue. See paragraph (c)(1) of this section for the treatment of
refunding issues of $1 million or less.
(2) $10 million or less. (i) Under section 103(b)(6)(D), the issuing
State or local governmental unit may elect to have an aggregate
authorized face amount of $10 million or less, in lieu of the $1 million
exemption otherwise provided for in section 103(b)(6)(A), with respect
to issues of obligations that are industrial development bonds (within
the meaning of section 103(b)(2)) issued after October 24, 1968. If the
election is made in a timely manner, the bonds will be treated as
obligations of a State or local governmental unit described in section
103(a)(1) and Sec. 1.103-1 if the sum of--
(a) The aggregate face amount of the issue including the aggregate
outstanding face amount of any prior $1 million or $10 million exempt
small issues taken into account under section 103(b)(6)(B) and paragraph
(d) of this section, and
(b) The aggregate amount of ``section 103(b)(6)(D) capital
expenditures'' (within the meaning of paragraph (b)(2)(ii) of this
section),
is $10 million or less. In the case of an issue of obligations that
qualified for exemption under section 103(b)(6)(A)
[[Page 382]]
and this paragraph, if a section 103(b)(6)(D) capital expenditure made
after the date of issue has the effect of making taxable the interest on
the issue, under section 103(b)(6)(G) the loss of tax exemption for the
interest shall begin only with the date on which the expenditure that
caused the issue to cease to qualify under the $10 million limit was
paid or incurred. See paragraph (b)(2)(vi) of this section for the time
and manner in which the issuer may elect the $10 million exemption. See
section 103(b)(6)(H) and paragraph (c)(2) of this section for the
treatment of certain refinancing issues of $10 million of less.
(ii) The term ``section 103(b)(6)(D) capital expenditure'' is
defined in this subdivision. Special rules for applying such definition
in the case of certain expenditures paid or incurred by a State or local
governmental unit are prescribed in subdivision (iii) of this
subparagraph. Except as excluded by subdivision (iv) or (v) of this
subparagraph, an expenditure (regardless of how paid, whether in cash,
notes, or stock in a taxable or nontaxable transaction) is a section
103(b)(6)(D) capital expenditure if--
(a) The capital expenditure was financed other than out of the
proceeds of issues to the extent such issues are taken into account
under paragraph (b)(2)(i)(a) of this section.
(b) The capital expenditures were paid or incurred during the 6-year
period which begins 3 years before the date of issuance of the issue in
question 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 (as
defined in section 103(b)(6)(C) and paragraph (e) of this section),
(d) Both facilities referred to in (c) of this subdivision were
(during the period described in (b) of this subdivision or a part
thereof) located in the same incorporated municipality or in the same
county outside of the incorporated municipalities 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) determined, for this purpose, without regard to any rule of the
Code which permits expenditures properly chargeable to capital account
to be treated as current expenses. With respect to obligations issued on
or after August 8, 1972, determinations under the preceding sentence
shall be made by including any expenditure which may, under any rule or
election under the Code, be treated as a capital expenditure (whether or
not such expenditure is so treated). With respect to obligations issued
on or after August 8, 1972, for purposes of this subparagraph, capital
expenditures made with respect to a contiguous or integrated facility
which is located on both sides of a border between two or more political
jurisdictions are made with respect to a facility located in all such
jurisdictions and, therefore, shall be treated as if they were made in
each such political jurisdiction.
(iii) Amounts properly chargeable to capital account under
subdivision (ii) (e) of this subparagraph include capital expenditures
made by a State or local governmental unit with respect to an exempt
facility or an industrial park, within the 6-year period described in
subdivision (ii)(b) of this subparagraph, out of the proceeds of bond
issues to which section 103(b)(1) did not apply by reason of section
103(b) (4) or (5) (relating to certain exempt activities and industrial
parks). Thus, for example, the cost to the lessor of a leased plantsite
financed out of the proceeds of an issue for an exempt air pollution
control facility under section 103(b)(4)(F) and paragraph (g) of
Sec. 1.103-8 would constitute a section 103(b)(6)(D) capital
expenditure. However, in the case of an industrial park, only the land
costs allocated on an area basis to the plantsite and the actual cost of
any improvements made on the plantsite, or to be used principally in
connection with the actual plantsite occupied by a principal user or a
related person, shall be taken into account as capital expenditures.
Where the actual amount
[[Page 383]]
of capital expenditures made with respect to a facility by a person
(including a State or local governmental unit) other than the user of
such facility (or a related person) cannot be ascertained, the fair
market value of the property with respect to which the capital
expenditures were made, at the time of such capital expenditures, shall
be deemed to be the amount of such capital expenditures. In the case of
a transaction which is not in form a purchase but which is treated as a
purchase for Federal income tax purposes, the purchase price for Federal
income tax purposes shall constitute a capital expenditure.
(iv) A section 103(b)(6)(D) capital expenditure shall not include
any ``excluded expenditure'' described in (a) through (e) of this
subdivision (iv).
(a) A capital expenditure is an excluded expenditure if either it is
made by a public utility company which is not the principal user of the
facility financed by the proceeds of the issue in question (or a related
person) with respect to property of such company, or it is made by a
State or local governmental unit with respect to property of such unit,
and if in either case it meets all of the following three conditions:
Such property of such company or unit (as the case may be) must be used
to provide gas, water, sewage disposal services, electric energy, or
telephone service. Such property must be installed in, or connected to,
the facility but must not consist of property which is such an integral
part of the facility that the cost of such property is ordinarily
included as part of the acquisition, construction, or reconstruction
cost of such facility. Such property must be of a type normally paid for
by the user (or a related person) in the form of periodic fees based
upon time or use.
(b) A capital expenditure is an excluded expenditure if it is made
by a person other than the user, a related person, or a State or local
governmental unit and if it is made with respect to tangible personal
property (within the meaning of paragraph (c) of Sec. 1.48-1), or
intangible personal property, leased to the user (or a related person)
of a facility. However, the preceding sentence shall apply only if such
personal property is leased by the manufacturer of such tangible or
intangible personal property, or by a person in the trade or business of
leasing property the same as, or similar to, such personal property, and
only if, pursuant to general business practice, property of such type is
ordinarily the subject of a lease.
(c) A capital expenditure is an excluded expenditure if it is made
to replace property damaged or destroyed by fire, storm, or other
casualty, to the extent that these expenditures do not exceed in dollar
amount the fair market value (determined immediately before the
casualty) of the property replaced.
(d) A capital expenditure is an excluded expenditure if it is
required by a change made after the date of issue in a Federal or State
law, or a local ordinance which has general application, or if it is
required by a change made after such date in rules and regulations of
general application issued under such law or ordinance.
(e) A capital expenditure is an excluded expenditure if it is
required by or arises out of circumstances which could not reasonably be
foreseen on the date of issue or which arise out of a mistake of law or
fact. However, the aggregate dollar amount taken into account under this
subdivision (e) with respect to any issue may not exceed $1 million.
With respect to expenditures incurred prior to December 11, 1971, the
dollar amount specified in the preceding sentence shall be $250,000.
(v)(a) If the assets of a corporation are acquired by another
corporation in a transaction to which section 381(a) (relating to
carryovers in certain corporate acquisitions) applies, the exchange of
consideration by the acquiring corporation for such assets is not a
section 103(b)(6)(D) capital expenditure by such acquiring corporation.
(b) However, if an exchange referred to in (a) of this subdivision
occurs during the 6-year period beginning 3 years before the date of
issuance of an issue of obligations and ending 3 years after such date,
the transferor and transferee shall be treated as having been related
persons for the portion of such 6-year period preceding the date of the
exchange for purposes of determining
[[Page 384]]
whether section 103(b)(6)(D) capital expenditures have been made. For
purposes of this subdivision (b), the date of an exchange to which
section 381 applies shall be the date of distribution or transfer within
the meaning of paragraph (b) of Sec. 1.381(b)-1.
(c) If section 351(a) applies to a transfer of property to a
corporation solely in exchange for its stock or securities, the issuance
of such stock or securities in such exchange is not a section
103(b)(6)(D) capital expenditure by such corporation.
(d) However, if such a transfer referred to in (c) of this
subdivision occurs during the 6-year period beginning 3 years before the
date of issuance of an issue of obligations and ending 3 years after
such date, and if, with respect to the property transferred,
expenditures made within such period would have been section
103(b)(6)(D) capital expenditures if the transferor and transferee had
been related persons for such period, then such expenditures shall be
considered to be section 103(b)(6)(D) capital expenditures made by the
transferee. In addition, if a transferor and transferee are related
persons immediately following such transfer, such transferor and
transferee shall also be treated as having been related persons for the
portion of such 6-year period preceding the date of such transfer.
(e) For purposes of this subdivision (v), the term ``issue of
obligations'' means an issue being tested for purposes of qualifying or
continuing to qualify under an election pursuant to section 103(b)(6)(D)
as to which an amount which would be a section 103(b)(6)(D) capital
expenditure solely by reason of (b) or (d) of this subdivision must be
taken into account.
(f) If with respect to an issue of obligations an expenditure would
not have been a section 103(b)(6)(D) capital expenditure but for the
application of (b) or (d) of this subdivision, and if such section
103(b)(6)(D) capital expenditure has the effect of making taxable the
interest on an issue of obligations which qualified for exemption under
section 103(b)(6)(A) and this paragraph, the loss of tax exemption for
such interest shall begin not earlier than the date of such exchange or
transfer referred to in this subdivision (v).
(vi) The issuer may make the election provided by section
103(b)(6)(D) and this paragraph (b)(2) (assuming that the bonds
otherwise qualify under section 103(b)(6) by noting the election
affirmatively at or before the time of issuance of the issue in question
on its books or records with respect to the issue. The term ``books or
records'' includes the bond resolution or other similar legislation for
the issue in question as well as the bond transcript or other
compilation of bond and bond-related documents. If the issuer fails to
make an election at the time and in the manner prescribed in this
paragraph (b)(2), the issue will not be treated as described in section
103(b)(6)(D), and interest thereon will be includible in gross income.
(c) Refunding or refinancing issue exemption--(1) $1 million or less
refunding issue. Section 103(b)(6)(A) also provides that section
103(b)(1) shall not apply to any debt obligation issued by a State or
local governmental unit as part of an issue the aggregate authorized
face amount of which is $1 million or less, if substantially all of the
proceeds of such issue are to be used--
(i) To redeem part of 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.
(2) 10 million or less refinancing issue. Section 103(b)(6)(H)
provides that section 103(b)(1) shall not apply to any debt obligation
issued by a governmental unit as part of an issue which is $10 million
or less if the condition of 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 $10 million exemption in lieu of the $1 million limit for a
refunding issue may be
[[Page 385]]
made only if each prior issue being redeemed is an issue which qualified
either for the $1 million exemption or, by reason of an election under
section 103(b)(6)(D), for the $10 million exemption. In addition, in
applying the capital expenditures test under section 103(b)(6)(D)(ii)
and paragraph (b)(2)(i)(b) of this section to refinancing issues,
section 103(b)(6)(D) capital expenditures are taken into account only
for purposes of determining whether prior issues which were made under
the section 103(b)(6)(D) election qualified under section 103(b)(6)(A)
and would have continued to qualify under that section but for the
redemption.
(d) Certain prior issues taken into account--(1) In general. Section
103(b)(6)(B) provides, in effect, that if (i) a prior issue specified in
subparagraph (2) of this paragraph is an exempt small issue (including
for this purpose an exempt small refunding issue) under section
103(b)(6)(A) and this section, and (ii) such prior issue is outstanding
at the time of issuance of a subsequent issue, then in determining the
aggregate face amount of such subsequent issue (for purposes of
determining whether such issue is a $1 million or $10 million exempt
small issue under section 103(b)(6)(A) and this section) there shall be
taken into account the outstanding face amount of such prior exempt
small issue. For purposes of this paragraph, the outstanding face amount
of a prior exempt small issue does not include the face amount of any
obligation which is to be redeemed from the proceeds of such subsequent
issue.
(2) Prior issues specified. The face amount of an outstanding prior
exempt small issue is taken into account under subparagraph (1) of this
paragraph if--
(i) The proceeds of both the prior exempt small issue and of the
subsequent issue (whether or not the State or local governmental unit
issuing such obligation is the same unit for each such issue) are or
will be used primarily with respect to facilities located or to be
located in the same incorporated municipality or located or to be
located in the same county outside of an incorporated municipality in
such county (and, for purposes of this subdivision, on or after August
8, 1972, a contiguous or integrated facility which is located on both
sides of a border between two or more political jurisdictions shall be
treated as if it is entirely within each such political jurisdiction),
and
(ii) The principal user of the financed facilities referred to in
subdivision (i) of this subparagraph is or will be the same person or
two or more related persons (as defined in section 103(b)(6)(C) and
paragraph (e) of this section).
(3) Rules of application. The rules of this paragraph shall apply--
(i) Only in the case of outstanding prior exempt small issues which
are industrial development bonds to which section 103(b)(1) would have
applied but for the provisions of section 103(b)(6). Thus, for example,
the provisions of this paragraph do not apply in respect of a prior
issue of obligations issued on or before April 30, 1968. In addition,
the provisions of this paragraph do not apply in respect of a prior
issue for an exempt facility under section 103(b)(4) and Sec. 1.103-8,
or for an industrial park under section 103(b)(5) and Sec. 1.103-9,
whether or not the issue might also have qualified as an exempt small
issue under section 103(b)(6)(A) and this section.
(ii) To all prior exempt small issues which meet the requirements of
this paragraph. Thus, for example, in determining the aggregate face
amount of an issue under section 103(b)(6)(A), the outstanding face
amount of prior $1 million or $10 million exempt small issues which meet
the requirements of this paragraph shall be taken into account in
determining the aggregate face amount of a subsequent issue being tested
for the $1 million small issue exemption. Similarly, in determining the
aggregate face amount of an issue under section 103(b)(6)(A) and (D),
the outstanding face amount of prior $1 million or $10 million exempt
small issues which meet the requirements of this paragraph shall be
taken into account in determining the aggregate face amount of a
subsequent issue being tested for the $10 million small issue exemption.
(e) Related persons. For purposes of section 103(b) and Secs. 1.103-
7 through 1.103-11, the term ``related person''
[[Page 386]]
means a person who is related to another person if, on the date of issue
of an issue of obligations--
(1) The relationship between such persons would result in a
disallowance of losses under section 267 (relating to disallowance of
losses, etc., between related taxpayers) and section 707(b) (relating to
losses disallowed, etc., between partners and controlled partnerships)
and the regulations thereunder, or
(2) Such persons are members of the same controlled group of
corporations, as defined in section 1563(a), relating to definition of
controlled group of corporations (except that ``more than 50 percent''
shall be substituted for ``at least 80 percent'' each place it appears
in section 1563(a)) and the regulations thereunder.
(f) Disqualification of certain small issues. (1) Section 103(b)(6)
shall not apply to any obligation issued after April 24, 1979, which is
part of an issue, a significant portion of the proceeds of which are to
be used directly or indirectly to provide residential real property for
family units. For purposes of the preceding sentence, the term
``residential real property for family units'' means residential rental
projects (within the meaning of Sec. 1.103-8(b)) and owner-occupied
residences (within the meaning of section 103A).
(2) For purposes of paragraph (f)(1), a significant portion of the
proceeds of an issue are used to provide residential real property for
family units if 5 percent or more of the proceeds are so used.
(g) Examples. The application of the rules contained in section
103(b)(6) and this section are illustrated by the following examples:
Example (1). County A and corporation X enter into an arrangement
under which the county will provide a factory which X will lease for 25
years. The arrangement provides (1) that A will issue $1 million of
bonds on March 1, 1970, (2) that the proceeds of the bond issue will be
used to acquire land in County A (but not in an incorporated
municipality) and to construct and equip a factory on such land in
accordance with X's specifications, (3) that X will rent the facility
for 25 years at an annual rental equal to the amount necessary to
amortize the principal and pay the interest on the outstanding bonds,
and (4) that such payments by X and the facility itself shall be the
security for the bonds. Although the bonds issued are industrial
development bonds, the bonds are an exempt small issue under section
103(b)(6)(A) and this section since the aggregate authorized face amount
of the bond issue is $1 million or less and all of the proceeds of the
bond issue are to be used to acquire and improve land and acquire and
construct depreciable property. The result would be the same if the
arrangement provided that X would purchase the facility from A.
Example (2). The facts are the same as in example (1) except that,
instead of acquiring land and constructing a new factory, the
arrangement provides that A will acquire a vacant existing factory
building and rebuild and equip the building in accordance with X's
specifications. The bonds are an exempt small issue for the same reasons
as in example (1).
Example (3). The facts are the same as in example (1) or (2) except
that the financed facilities are additions to facilities which were
financed by an issue of bonds to which section 103(b)(1) does not apply
because such bonds were issued prior to May 1, 1968, or were subject to
the transitional provisions of Sec. 1.103-12. The bonds are an exempt
small issue since neither of the prior bond issues are taken into
account under section 103(b)(6)(B) and this section in determining the
status of industrial development bonds which are issued after April 30,
1968, and which are not subject to the transitional provisions of
Sec. 1.103-12.
Example (4). The facts are the same as in example (1) except that,
subsequently, corporation X proposes to County A that A build a $400,000
warehouse located in Town M (an unincorporated town located in County A)
for X under terms similar to the factory arrangement described in
example (1). On the proposed issue date of the subsequent bond issue,
$600,000 of the first exempt small issue will be outstanding. If A
issues $400,000 of bonds for such purposes, the bonds will be an exempt
small issue under section 103(b)(6) and this section since, under the
rules of section 103(b)(6)(B) and paragraph (d) of this section, if the
aggregate authorized face amount of the new issue and the outstanding
prior exempt small issue will be $1 million or less, the new issue will
be an exempt small issue. If, however, the aggregate authorized face
amount of the prior issue outstanding on the date of the subsequent
issue were in excess of $600,000, the subsequent issue would not qualify
as an exempt small issue because (1) the combined aggregate face amount
of the outstanding prior issue and the new issue would be in excess of
$1 million, (2) the facilities financed by both issues are to be located
in unincorporated areas in the same county, (3) the same taxpayer will
be the principal user of both facilities, and (4) but
[[Page 387]]
for the rules of section 103(b)(6)(B) and paragraph (d) of this section
the prior issue would be an exempt small issue.
Example (5). The facts are the same as in example (1) except that
subsequently corporation X proposes to City P and City R (incorporated
municipalities located in County A) that P and R each issue bonds and
each build $1 million facilities to be located in Cities P and R for the
use of X under terms similar to the arrangement in example (1). Each of
the $1 million issues will be an exempt small issue because each
proposed facility is located within a different incorporated
municipality and the proceeds of the prior outstanding exempt small
issue were used to construct facilities outside of an incorporated area.
Example (6). The facts are the same as in example (1) except that
$95,000 of the $1 million will be used by the corporation as working
capital. The bonds are an exempt small issue for the same reason as in
example (1) since substantially all of the proceeds will be used for the
acquisition of land and the construction of depreciable property.
Example (7). The facts are the same as in example (1) except that on
November 1, 1969, County A issued $10 million of industrial development
bonds, all of the proceeds of which were issued for the acquisition of
land as the site for an industrial park within the meaning of section
103(b)(5) and Sec. 1.103-9. The proceeds of the $1 million of bonds
issued in 1970 will be used to construct a factory for corporation X to
be located in the industrial park. The bonds issued in 1970 are
industrial development bonds within the meaning of section 103(b)(2) and
Sec. 1.103-7. Since, however, the prior 1969 issue is not an issue to
which section 103(b)(6)(A) applied (see paragraph (d)(3)(i) of this
section), the bonds issued in 1970 are an exempt small issue for the
reasons stated in example (1).
Example (8). County B enters into three separate arrangements with
three unrelated corporations whereby the county will provide separate
storage facilities for each corporation. The arrangement provides (1)
that the county will issue bonds and loan to each corporation $250,000
of the proceeds which will be used to acquire land in the county and to
construct the facilities, (2) that the rental payments by the
corporations will be equal to the amount necessary to amortize the
principal and pay the interest on any outstanding bonds issued by the
county, and (3) that the payments by the corporations and the facilities
themselves shall be the security for the industrial development bonds.
For convenience, the county issues one series of bonds in the face
amount of $750,000 rather than three separate series of bonds of
$250,000 each. The issue is an exempt small issue under section
103(b)(6)(A) and paragraph (b)(1) of this section since the aggregate
authorized face amount of the bond issue is $1 million or less, and all
of the proceeds of the bond issue are to be used to acquire and improve
land and acquire and construct depreciable property.
Example (9). City C and corporation Y enter into an arrangement
under which C will provide a factory which Y will lease for 25 years.
The arrangement provides (1) that C will issue $4 million of bonds on
March 1, 1969, after making the election under section 103(b)(6)(D) and
paragraph (b)(2) of this section, (2) that the proceeds of the bond
issue will be used to acquire land in the city and to construct and
equip a factory on such land in accordance with Y's specifications, (3)
that Y will rent the facilities for 25 years at an annual rental equal
to the amount necessary to amortize the principal and pay the interest
on the outstanding bonds, (4) that such payments by Y and the facility
itself shall be the security for the bonds, and (5) that, if corporation
Y pays or incurs capital expenditures in excess of $1 million within 3
years from the date of issue which disqualify the bonds as an exempt
small issue under section 103(b)(6)(D), it will either furnish funds to
C to redeem such bonds at par or at a premium, or increase the rental
payments to C in an amount sufficient to pay a premium interest rate.
Although the bonds issued are industrial development bonds, they are an
exempt small issue under section 103(b)(6)(A) by reason of the election
under section 103(b)(6)(D) and paragraph (b)(2) of this section, since
the aggregate authorized face amount of the bond issue is $5 million or
less and all of the proceeds of the bond issue are to be used to acquire
and improve land and acquire and construct depreciable property. The
provisions for redemption of the bonds or an increase in rental if the
bonds are disqualified as an exempt small issue under section
103(b)(6)(A) will not disqualify an otherwise valid election under
section 103(b)(6)(D) and paragraph (b)(2) of this section.
Example (10). The facts are the same as in example (9) except that
corporation Y subsequently proposed to the city that it build a $1
million warehouse next to the plant for the use of Y under terms similar
to the factory arrangement. Assume further that the factory building was
completed by March 1, 1970, and that on January 15, 1972, the proposed
issue date of the subsequent bond issue, $2 million of the first exempt
small issue will be outstanding. In determining the aggregate authorized
face amount of the new issue, the original face amount of a prior
outstanding issue must be reduced by that portion which is to be
redeemed before it is added to the face amount of the new issue.
Therefore, if the city issues $3 million of bonds to redeem the
remaining $2 million of bonds and to construct the warehouse the bonds
will be an exempt small issue under section 103(b)(6)(A) if an election
is made
[[Page 388]]
under section 103(b)(6)(D) and paragraph (b)(2) of this section since
(1) the face amount of the new issue ($3 million), plus (2) the face
amount of the prior outstanding exempt small issue minus the amount of
such issue to be refunded ($2 million minus $2 million), plus (3)
capital expenditures during the preceding 3 years financed other than
out of the proceeds of outstanding issues to which section 103(b)(6)(A)
and paragraph (b) of this section applied ($2 million), do not exceed $5
million. If, however, the amount of the January 15, 1972, issue were
$3\1/2\ million, the issue would not qualify as an exempt small issue
under section 103(b)(6)(A) and paragraph (b)(2) of this section.
Example (11). The facts are the same as in example (9), except that
on June 15, 1971, Y purchases from an unrelated motor carrier business a
warehouse terminal in the same city at a cost of $250,000 and tractor-
trailers and other automotive equipment based at the terminal at a cost
of $1 million. This subsequent expenditure by Y has the effect of making
the interest on the city C bonds includable in the gross income of the
holders of such bonds as of June 15, 1971, because the face amount of
the March 1, 1969, issue ($4 million) plus the subsequent capital
expenditures within 3 years of the date of issue ($1,250,000) exceed $5
million. (See section 103(b)(6)(D) and paragraph (b)(2)(i) of this
section.)
Example (12). The facts are the same as in example (9), except that
in March, 1970, Y will move $3 million of additional used machinery and
equipment into the factory from its factory in another city. The
expenditures for such machinery and equipment were incurred by Y more
than 3 years prior to the date of issue of the bonds. The transfer of
such used equipment into city C does not constitute a section
103(b)(6)(D) capital expenditure within the meaning of paragraph
(b)(2)(ii) of this section since the expenditures with respect to such
property were incurred more than 3 years prior to the date of issue of
the bonds. Had the capital expenditures with respect to such property
been incurred during the 6-year period beginning 3 years before the date
of issue of the bonds and in the 3 years after such date, they would
constitute section 103(b)(6)(D) capital expenditures.
Example (13). The facts are the same as in example (9), except that
in March 1970, corporation Y enters into an arrangement with respect to
machinery and equipment to be used in the facility. The arrangement is
labeled by the parties as a lease but is treated as a sale for Federal
income tax purposes. The amount treated as the purchase price of the
machinery and equipment is a section 103(b)(6)(D) capital expenditure.
Example (14). On February 1, 1970, city D issues $5 million of its
bonds to finance construction of an addition to the manufacturing plant
of corporation Z. The bonds will be secured by the facility and lease
payments to be made by Z which will be sufficient to pay the principal
and interest on such bonds. Assume that the bonds qualify as an exempt
small issue under section 103(b)(6)(A) pursuant to an election under
section 103(b)(6)(D) and paragraph (b)(2) of this section. On February
1, 1971, D plans to issue $1 million of its bonds to construct a
pollution control facility to be leased to Z for use at its
manufacturing plant. The rental payments from the lease will be
sufficient to pay the principal and interest on the bonds. The bonds
will be secured by such facility and the lease payments. Capital
expenditures for the pollution control facility will be paid or incurred
beginning before February 1, 1973. Although the pollution control
facility is an exempt facility under section 103(b)(4)(F) and paragraph
(g) of Sec. 1.103-8, amounts used for the pollution control facility
shall be considered to be a section 103(b)(6)(D) capital expenditure and
the interest on the February 1, 1970, issue will become taxable as of
the date such capital expenditure began to be paid or incurred. See
section 103(b)(6)(G) and paragraph (b)(2)(i) of this section.
Example (15). On February 1, 1970, City E issues $500,000 of its
bonds to acquire and develop an industrial park within the meaning of
section 103(b)(5) and paragraph (b) of Sec. 1.103-9. The park consists
of 100 acres and is divided into one 50 acre plantsite and 4 smaller
sites. The aggregate acquisition cost of the undeveloped land is
$150,000 or an average per acre cost of $1,500. Roads, sidewalks,
sewers, utilities, sewage, and waste disposal facilities serving the
entire industrial park cost $300,000. On September 1, 1970, E leases to
corporation Y for 30 years the 50 acre plantsite (with an allocated cost
of $75,000) and a railroad spur track from the railroad right of way to
Y's plantsite for Y's exclusive use. The spur track was constructed
using $50,000 of the proceeds of the industrial park bond issue. E also
proposes to issue on September 1, 1970, $4,875,000 of its bonds to
construct and equip a building on the leased plantsite to be leased to Y
at an additional rental sufficient to pay the principal and interest on
this issue of bonds. The September 1, 1970, issue will be an exempt
small issue under section 103(b)(6)(A) pursuant to an election under
section 103(b)(6)(D) and paragraph (b)(2) of this section since the sum
of the amount of the second issue ($4,875,000) and the capital
expenditures allocated to the plantsite ($75,000 for 50 acres of land
plus $50,000 for the railroad spur tract, totaling $125,000) does not
exceed $5 million. The sum of $300,000 which was spent in development of
the industrial park provided facilities which will serve or benefit the
users generally and
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hence under paragraph (b)(2)(iii) of this section is not considered to
have provided facilities as to which Y will be the principal user.
Example (16). On June 1, 1970, corporation Z simultaneously enters
into separate arrangements with City F and City G under which each city
will issue a $5 million exempt small issue of bonds the proceeds of
which will be used by Z to construct separate facilities in each city.
By June 1, 1971, the facilities have been completed in the respective
cities. On January 1, 1972, Cities F and G, through a valid legal
proceeding, merge into a new City FG. Since in this case F and G were
separate cities on June 1, 1970 (the date of the bond issues), the
factories are not considered to be located in the same incorporated
municipality. Accordingly, each $5 million issue by City F and G will
continue to qualify as an exempt small issue.
Example (17). On June 1, 1973, City H issues an exempt small issue
of $4.75 million to finance a facility of corporation S to be located in
City H. On October 1, 1974, S and corporation T, previously unrelated to
S, consummated a statutory merger which qualifies as a reorganization
described in section 368(a)(1)(A) and thus as a transaction described in
section 381(a). In the transaction, T transferred to S assets with a
fair market value of $1.5 million in exchange for stock of S, $300,000
of securities of S, and $100,000 cash. On March 23, 1971, T made
$400,000 of capital expenditures for an addition to its factory located
in City H. For purposes of testing the H issue of June 1, 1973, such
expenditures would have been section 103(b)(6)(D) capital expenditures
if T and S had been related persons. Under the provisions of paragraph
(b)(2)(v)(a) of this section, the exchange of $1.5 million of stock,
securities, and cash by S does not constitute a section 103(b)(6)(D)
capital expenditure. Since, however, S and T are treated as related
persons starting 3 years prior to the date of issue of the obligations,
the $400,000 of expenditures by T constitute section 103(b)(6)(D)
capital expenditures. Thus, the interest on the June 1, 1973, issue of
obligations would become taxable (since the $5 million limit would be
exceeded) on the date of the merger.
Example (18). In 1965 City I issues $10 million of industrial
development bonds to construct and equip a factory for corporation Z. In
1975 the remaining principal amount of the bonds outstanding is $4.1
million. If I issues $4.5 million of bonds to redeem the balance of the
prior issue, and for other purposes, such issue cannot qualify as an
exempt small issue under section 103(b)(6)(D) and paragraph (b)(2) of
this section even though at the time of issue the interest on the 1965
bonds was tax-exempt since the prior issue must be one which qualified
under section 103(b)(6)(A) and this section. Further, the 1975 issue
will be an issue of industrial development bonds notwithstanding the
provisions of paragraph (d)(2) of Sec. 1.103-7 which provides that
certain bonds issued to refund an issue of obligations issued on or
before April 30, 1968 (or January 1, 1969, in certain cases) will not be
so treated. Paragraph (d)(2) of Sec. 1.103-7 is not applicable because
the 1975 issue makes funds available for a purpose other than the debt
service obligation on the 1965 bonds.
Example (19). In 1969 City J issues $4 million of industrial
development bonds which qualify as an exempt small issue under section
103(b)(6)(A) pursuant to an election under section 103(b)(6)(D) and
paragraph (b)(2) of this section. In 1971, by reason of a $2 million
addition to the factory built with the proceeds of the issue, the 1969
exempt small issue loses its tax-exempt status. In 1972, the city issues
a $5 million issue to redeem the prior 1969 issue. The redemption issue
will not qualify as an exempt small issue since the prior 1969 issue did
not continue to qualify under section 103(b)(6)(A) and this section.
[T.D. 7199, 37 FR 15494, Aug. 3, 1972; 37 FR 16177, Aug. 11, 1972; 37 FR
17826, Sept. 1, 1972, as amended by T.D. 7511, 42 FR 54285, Oct. 5,
1977; T.D. 7840, 47 FR 46084, Oct. 15, 1982; 51 FR 16299, May 2, 1986]