[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: 26CFR1.103-7]
[Page 354-361]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.103-7 Industrial development bonds.
(a) In general. Under section 103(c)(1) and this section, an
industrial development bond issued after April 30, 1968, shall be
treated as an obligation not described in section 103(a)(1) and
Sec. 1.103-1. Accordingly, interest paid on such a bond is includable in
gross income unless the bond was issued by a State, or local
governmental unit to finance certain exempt facilities (see section
103(c)(4) and Sec. 1.103-8), to finance an industrial park (see section
103(c)(5) and Sec. 1.103-9), or as part of an exempt small issue (see
section 103(c)(6) and Sec. 1.103-10). For applicable rules when an
industrial development bond is held by a substantial user (or a person
related to a substantial user) of such an exempt facility, or an
industrial park, or a facility financed with the proceeds of such an
exempt small issue, see section 103(c)(7) and Sec. 1.103-11. See also
Sec. 1.103-12 for the transitional provisions concerning the interest
paid on certain industrial development bonds issued before January 1,
1969, and certain other industrial development bonds. Even if section
103(c) does not prevent a bond from being treated as an obligation
described in section 103(a)(1) and Sec. 1.103-1, such bond shall
nevertheless be treated as an obligation which is not described in
section 103(a)(1) and Sec. 1.103-1 if under section 103(d) it is an
arbitrage bond. For purposes of section 103(c), the term ``issue''
includes a single obligation such as a single note issued in connection
with a bank loan as well as a series of notes or bonds.
(b) Industrial development bonds--(1) Definition. For purposes of
this section, the term ``industrial development bond'' means any
obligation--
(i) Which is issued as part of an issue all or a major portion of
the proceeds of which are to be used directly or indirectly in any trade
or business carried on by any person who is not an exempt person (as
defined in subparagraph (2) of this paragraph), and
(ii) The payment of the principal or interest on which, under the
terms of such obligation or any underlying arrangement (as described in
subparagraph (4) of this paragraph), is in whole or in major part (i.e.,
major portion)--
(a) Secured by any interest in property used or to be used in a
trade or business,
(b) Secured by any interest in payments in respect of property used
or to be used in a trade or business, or
(c) To be derived from payments in respect of property, or borrowed
money, used or to be used in a trade or business.
See subparagraphs (3) and (4) of this paragraph for the trade or
business test and the security interest test respectively. See
Sec. 1.103-8(a)(6) to determine the amount of proceeds of an issue for
which the amount payable during each annual period over the term of the
issue is less than the amount of interest accruing thereon in such
period, e.g., in the case of an issue sold by the issuer for less than
its face amount.
(2) Exempt person. The term ``exempt person'' means a governmental
unit as defined in this subparagraph, or an organization which is
described in section 501(c)(3) and this subparagraph and is exempt from
taxation under section 501(a). For purposes of this subparagraph, the
term ``governmental unit'' means a State or local governmental unit (as
defined in Sec. 1.103-1). For purposes of this subparagraph, the term
``governmental unit'' also includes the United States of America (or an
agency or instrumentality of the United States of America), but only in
the case of obligations (i) issued on or before August 3, 1972, or (ii)
issued after August 3, 1972, with respect to which a bond resolution or
any other official action was taken and in reliance on such action
either (a) construction of such facility to be financed with such
obligations commenced or (b) a binding
[[Page 355]]
contract was entered into, or an irrevocable bid was submitted, prior to
August 3, 1972, or (iii) issued after August 3, 1972, with respect to a
program approved by Congress prior to such date but only if (a) a
portion of such program has been financed by obligations issued prior to
such date, to which section 103(a) applied pursuant to a ruling issued
by the Commissioner or his delegate prior to such date and (b)
construction of one or more facilities comprising a part of such program
commenced prior to such date. For purposes of this subparagraph, a tax-
exempt organization is an exempt person only with respect to a trade or
business it carries on which is not an unrelated trade or business.
Whether a particular trade or business carried on by a tax-exempt
organization is an unrelated trade or business is determined by applying
the rules of section 513(a) (relating to general rule for unrelated
trade or business) and the regulations thereunder to the tax-exempt
organization without regard to whether the organization is an
organization subject to the tax imposed by section 511 (relating to
imposition of tax on unrelated business income of charitable, etc.,
organizations).
(3) Trade or business test. (i) The trade or business test relates
to the use of the proceeds of a bond issue. The test is met if all or a
major portion of the proceeds of a bond issue is used in a trade or
business carried on by a nonexempt person. For example, if all or a
major portion of the proceeds of a bond issue is to be loaned to one or
more private business users, or is to be used to acquire, construct, or
reconstruct facilities to be leased or sold to such private business
users, and such proceeds or facilities are to be used in trades or
businesses carried on by them, such proceeds are to be used in a trade
or business carried on by persons who are not exempt persons, and the
debt obligations comprising the bond issue satisfy the trade or business
test. If, however, less than a major portion of the proceeds of an issue
is to be loaned to nonexempt persons or is to be used to acquire or
construct facilities which will be used in a trade or business carried
on by a nonexempt person, the debt obligations will not be industrial
development bonds. Also, when publicly-owned facilities which are
intended for general public use, such as toll roads or bridges, are
constructed with the proceeds of a bond issue and used by nonexempt
persons in their trades or businesses on the same basis as other members
of the public, such use does not constitute a use in the trade or
business of a nonexempt person for purposes of the trade or business
test.
(ii) In determining whether a debt obligation meets the trade or
business test, the indirect, as well as the direct, use of the proceeds
is to be taken into account. For example, the debt obligations
comprising a bond issue do not fail to satisfy the trade or business
test merely because the State or local governmental unit uses the
proceeds to engage in a series of financing transactions for property to
be used by private business users in trades or businesses carried on by
them. Similarly, if such proceeds are to be used to construct facilities
to be leased or sold to any nonexempt person for use in a trade or
business it carries on, such proceeds are to be used in a trade or
business carried on by a nonexempt person and the debt obligations
comprising such issue satisfy the trade or business test. If such
proceeds are to be used to construct facilities to be leased or sold to
an exempt person who will, in turn, lease or sell the facilities to a
nonexempt person for use in a trade or business, such proceeds are to be
used in a trade or business carried on by a nonexempt person and the
debt obligations comprising such issue satisfy the trade or business
test. In addition, proceeds will be treated as being used in the trade
or business of a nonexempt person in situations involving other
arrangements, whether in a single transaction or in a series of
transactions, whereby a nonexempt person uses property acquired with the
proceeds of a bond issue in its trade or business.
(iii) The use of more than 25 percent of the proceeds of an issue of
obligations in the trades or businesses of nonexempt persons will
constitute the use of a major portion of such proceeds in such manner.
In the case of the direct or indirect use of the proceeds of an issue of
obligations or the direct or indirect use of a facility constructed,
[[Page 356]]
reconstructed, or acquired with such proceeds, the use by all nonexempt
persons in their trades or businesses must be aggregated to determine
whether the trade or business test is satisfied. If more than 25 percent
of the proceeds of a bond issue is used in the trades or businesses of
nonexempt persons, the trade or business test is satisfied. For special
rules with respect to the acquisition of the output of facilities, see
subparagraph (5) of this paragraph.
(4) Security interest test. The security interest test relates to
the nature of the security for, and the source of, the payment of either
the principal or interest on a bond issue. The nature of the security
for, and the source of, the payment may be determined from the terms of
the bond indenture or on the basis of an underlying arrangement. An
underlying arrangement to provide security for, or the source of, the
payment of the principal or interest on an obligation may result from
separate agreements between the parties or may be determined on the
basis of all the facts and circumstances surrounding the issuance of the
bonds. The property which is the security for, or the source of, the
payment of either the principal or interest on a debt obligation need
not be property acquired with bond proceeds. The security interest test
is satisfied if, for example, a debt obligation is secured by unimproved
land or investment securities used, directly or indirectly, in any trade
or business carried on by any private business user. A pledge of the
full faith and credit of a State or local governmental unit will not
prevent a debt obligation from otherwise satisfying the security
interest test. For example, if the payment of either the principal or
interest on a bond issue is secured by both a pledge of the full faith
and credit of a State or local governmental unit and any interest in
property used or to be used in a trade or business, the bond issue
satisfies the security interest test. For rules with respect to the
acquisition of the output of facilities see subparagraph (5) of this
paragraph.
(5) Trade or business test and security interest test with respect
to certain output contracts. (i) The use by one or more nonexempt
persons of a major portion of the subparagraph (5) output of facilities
such as electric energy, gas, or water facilities constructed,
reconstructed, or acquired with the proceeds of an issue satisfies the
trade or business test and the security interest test if such use has
the effect of transferring to nonexempt persons the benefits of
ownership of such facilities, and the burdens of paying the debt service
on governmental obligations used directly or indirectly to finance such
facilities, so as to constitute the indirect use by them of a major
portion of such proceeds. Such benefits and burdens are transferred and
a major portion of the proceeds of an issue is used indirectly by the
users of the subparagraph (5) output of such a facility which is owned
and operated by an exempt person where--
(a)(1) One nonexempt person agrees pursuant to a contract to take,
or to take or pay for, a major portion (more than 25 percent) of the
subparagraph (5) output (within the meaning of subdivision (ii) of this
subparagraph) of such a facility (whether or not conditional upon the
production of such output) or (2) two or more nonexempt persons, each of
which pays annually a guaranteed minimum payment exceeding 3 percent of
the average annual debt service with respect to the obligations in
question, agree, pursuant to contracts, to take, or to take or pay for,
a major portion (more than 25 percent) of the subparagraph (5) output of
such a facility (whether or not conditioned upon the production of such
output), and
(b) Payment made or to be made with respect to such contract or
contracts by such nonexempt person or persons exceeds a major part (more
than 25 percent) of the total debt service with respect to such issue of
obligations.
(ii) For purposes of this subparagraph--
(a) Where a contract described in subdivision (i) of this
subparagraph may be extended by the issuer of obligations described
therein, the term of the contract shall be considered to include the
period for which such contract may be so extended.
(b) The subparagraph (5) output of a facility shall be determined by
multiplying the number of units produced or to be produced by the
facility in 1 year
[[Page 357]]
by the number of years in the contract term of the issue of obligations
issued to provide such facility. The number of units produced or to be
produced by a facility in 1 year shall be determined by reference to its
nameplate capacity (or where there is no nameplate capacity, its maximum
capacity) without any reduction for reserves or other unutilized
capacity. The contract term of an issue begins on the date the output of
a facility is first taken, pursuant to a take or a take or pay contract,
by a nonexempt person and ends on the latest maturity date of any
obligation of the issue (determined without regard to any optional
redemption dates). If, however, on or before the date of issue of a
prior issue of governmental obligations issued to provide a facility,
the issuer makes a commitment in the bond indenture or related document
to refinance such prior issue with one or more subsequent issues of
governmental obligations, then the contract term of the issue shall be
determined with regard to the latest redemption date of any obligation
of the last such refinancing issue with respect to such facility
(determined without regard to any optional redemption dates). Where it
appears that the term of an issue (or the terms of two or more issues)
is extended for purposes of extending the contract term of an issue and
thereby increasing the subparagraph (5) output of the facility provided
by such issue, the subparagraph (5) output of such facility shall be
determined by the Commissioner without regard to the provisions of this
subdivision (b).
(c) The total debt service with respect to an issue of obligations
shall be the total dollar amount (excluding any penalties) payable with
respect to such issue over its entire term. The entire term of an issue
begins on its date of issue and ends on the latest maturity date of any
obligation of the issue (determined without regard to any optional
redemption dates). If, however, on or before the date of issue of a
prior issue of governmental obligations the issuer makes a commitment in
the bond indenture or related document to refinance such prior issue
with one or more subsequent issues of governmental obligations, the
entire term of the issue shall be determined with regard to the latest
redemption date of any obligation of the last such refinancing issue
(determined without regard to any optional redemption dates).
(d) Two or more nonexempt persons who are related persons (within
the meaning of section 103(c)(6)(C)) shall be treated as one nonexempt
person.
(c) Examples. The application of the rules contained in section
103(c) (2) and (3) and paragraph (b) of this section are illustrated by
the following examples:
Example (1). State A and corporation X enter into an arrangement
under which A is to provide a factory which X will lease for 20 years.
The arrangement provides (1) that A will issue $10 million of bonds, (2)
that the proceeds of the bond issue will be used to purchase land and to
construct and equip a factory in accordance with X's specifications, (3)
that X will rent the facility (land, factory, and equipment) for 20
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 will be the security for the
bonds. The bonds are industrial development bonds since they are part of
an issue of obligations (1) all of the proceeds of which are to be used
(by purchasing land and constructing and equipping the factory) in a
trade or business by a nonexempt person, and (2) the payment of the
principal and interest on which is secured by the facility and payments
to be made with respect thereto.
Example (2). The facts are the same as in example (1) except that
(1) X will purchase the facility, and (2) annual payments equal to the
amount necessary to amortize the principal and pay the interest on the
outstanding bonds will be made by X. The bonds are industrial
development bonds for the reasons set forth in example (1).
Example (3). State B and corporation X enter into an arrangement
under which B is to loan $10 million to X. The arrangement provides (1)
that B will issue $10 million of bonds, (2) that the proceeds of the
bond issue will be loaned to X to provide additional working capital and
to finance the acquisition of certain new machinery, (3) that X will
repay the loan in annual installments equal to the amount necessary to
amortize the principal and pay the interest on the outstanding bonds,
and (4) that the payments on the loan and the machinery will be the
security for only the payment of the principal on the bonds. The bonds
are industrial development bonds since they are part of an issue of
obligations (1) all of the proceeds of which are to be used in a trade
or business by a nonexempt person, and (2) the payment of
[[Page 358]]
the principal on which is secured by payments to be made in respect of
property to be used in a trade or business. The result would be the same
if only the payment of the interest on the bonds were secured by
payments on the loan and machinery.
Example (4). The facts are the same as in example (1), (2), or (3)
except that the annual payments required to be made by corporation X
exceed the amount necessary to amortize the principal and pay the
interest on the outstanding bonds. The bonds are industrial development
bonds for the reasons set forth in such examples. The fact that
corporation X is required to pay an amount in excess of the amount
necessary to pay the principal and interest on the bonds does not affect
their status as industrial development bonds. Similarly, if the annual
payments required to be made by corporation X were sufficient to pay
only a major portion of either the principal or the interest on the
outstanding bonds, the bonds would be industrial development bonds for
the reasons set forth in such examples.
Example (5). The facts are the same as in example (1), (2), (3), or
(4) except that the issuer is a political subdivision which has taxing
power and the bonds are general obligation bonds. Since both the trade
or business and the security interest tests are met, the bonds are
industrial development bonds notwithstanding the fact that they
constitute an unconditional obligation of the issuer payable from its
general revenues.
Example (6). (a) State C issues its general obligation bonds to
purchase land and construct a hotel for use by the general public (i.e.,
tourists, visitors, travelers on business, etc.). The bond indenture
provides (1) that C will own and operate the project for the period
required to redeem the bonds, and (2) that the project itself and the
revenues derived therefrom are the security for the bonds. The bonds are
not industrial development bonds since (1) the proceeds are to be used
by an exempt person in a trade or business carried on by such person,
and (2) a major portion of such proceeds is not to be used, directly or
indirectly, in a trade or business carried on by a nonexempt person. Use
of the hotel by hotel guests who are travelling in connection with
trades or businesses of nonexempt persons is not an indirect use of the
hotel by such nonexempt persons for purposes of section 103(c).
(b) The facts are the same as in paragraph (a) of this example
except that corporation Y enters into a long-term agreement with C that
Y will rent more than one-fourth of the rooms on an annual basis for a
period approximately equal to one half of the term of the bonds. The
bonds are industrial development bonds because (1) a major portion of
the proceeds used to construct the hotel is to be used in the trade or
business of corporation Y (a nonexempt person) and (2) a major portion
of the principal and interest on such issue will be derived from
payments in respect of the property used in the trade or business of Y.
Example (7). (a) State D and corporation Y enter into an agreement
under which Y will lease for 20 years three floors of a 12- story office
building to be constructed by D on land which it will acquire. D will
occupy the grade floor and the remaining eight floors of the building.
The portion of the costs of acquiring the land and constructing the
building which are allocated to the space to be leased by Y is not in
excess of 25 percent of the total costs of acquiring the land and
constructing the building. Such costs, whether attributable to the
acquisition of land or the construction of the building, were allocated
to leased space in the same proportion that the reasonable rental value
of such leased space bears to the reasonable rental value of the entire
building. From the facts and circumstances presented, it is determined
that such allocation was reasonable. The arrangement between D and Y
provides that D will issue $10 million of bonds, that the proceeds of
the bond issue will be used to purchase land and construct an office
building, that Y will lease the designated floor space for 20 years at
its reasonable rental value, and that such rental payments and the
building itself shall be security for the bonds. The bonds are not
industrial development bonds since a major portion of the proceeds is
not to be used, directly or indirectly, in the trade or business of a
nonexempt person.
(b) The facts are the same as in paragraph (a) of this example
except that corporation Y will lease four floors, and the costs
allocated to these floors are in excess of 25 percent of D's investment
in the land and building. The bonds are industrial development bonds
because (1) a major portion of the building is to be used in the trade
or business of a nonexempt person, and (2) a major portion of the
principal and interest on such issue is secured by the rental payments
on the building.
Example (8). The facts are the same as in paragraph (b) of example
(7) except that, instead of leasing any space to corporation Y, State D
will lease the four floors to numerous unrelated private business users
to be used in their trades or businesses. No lease will have a term
exceeding 2 years. A major portion of the principal and interest will be
paid from the revenues that D will derive from such leases. The fact
that the activities of D, an exempt person, may amount to a trade or
business of leasing property is not material, and the bonds are
industrial development bonds for the reasons set forth in paragraph (b)
of example (7). The result would be the same in the case of long-term
leases.
Example (9). State E issues its obligations to finance the
construction of dormitories
[[Page 359]]
for educational institution Z which is an organization described in
section 501(c)(3) and exempt from tax under section 501(a). The
dormitories are to be owned and operated by Z and their operation does
not constitute an unrelated trade or business. The bonds are not
industrial development bonds since the proceeds are to be used by an
exempt person in a trade or business carried on by such person which is
not an unrelated trade or business, as determined by applying section
513(a) to Z.
Example (10). State F issues its obligations to finance the
construction of a toll road and the cost of erecting related facilities
such as gasoline service stations and restaurants. Such related
facilities represent less than 25 percent of the total cost of the
project and are to be leased or sold to nonexempt persons. The toll road
is to be owned and operated by F. The revenues from the toll road and
from the rental of related facilities are the security for the bonds.
The bonds are not industrial development bonds since a major portion of
the proceeds is not to be used, directly or indirectly, in the trades or
businesses of nonexempt persons. The fact that vehicles owned by
nonexempt persons engaged in their trades or businesses may use the road
in common with, or as a part of, the general public is not material.
Example (11). City G issues its obligations to finance the
construction of a municipal auditorium which it will own and operate.
The use of the auditorium will be open to anyone who wishes to use it
for a short period of time on a rate-scale basis. The rights of such a
user are only those of a transient occupant rather than the full legal
possessory interests of a lessee. It is anticipated that the auditorium
will be used by schools, church groups, and fraternities, and numerous
commercial organizations. The revenues from the rentals of the
auditorium and the auditorium building itself will be the security for
the bonds. The bonds are not industrial development bonds because such
use is not a use in the trade or business of a nonexempt person.
Example (12). The facts are the same as in example (11) except that
one nonexempt person will have a 20-year rental agreement providing for
exclusive use of the entire auditorium for more than 3 months of each
year at a rental comparable to that charged short-term users. The bonds
are industrial development bonds since such use is a use in the trade or
business of a nonexempt person and, therefore, a major portion of the
proceeds of the issue will be used in the trade or business of a
nonexempt person and a major portion of the principal or interest on
such issue will be secured by a facility used in such trade or business
and by payments with respect to such facility.
Example (13). In order to construct an electric generating facility
of a size sufficient to take advantage of the economies of scale: (1)
City H will issue $50 million of its 25-year bonds and Z (a privately
owned electric utility) will use $100 million of its funds for
construction of a facility they will jointly own as tenants in common.
(2) Each of the participants will share in the ownership, output, and
operating expenses of the facility in proportion to its contribution to
the cost of the facility, that is, one-third by H and two-thirds by Z.
(3) H's bonds will be secured by H's ownership in the facility and by
revenues to be derived from the sale of H's share of the annual output
of the facility. (4) Because H will need only 50 percent of its share of
the annual output of the facility, it agrees to sell to Z 25 percent of
its share of such annual output for a period of 20 years pursuant to a
contract under which Z agrees to take or pay for such power in all
events. The facility will begin operation, and Z will begin to receive
power, 4 years after the City H obligations are issued. The contract
term of the issue will, therefore, be 21 years. (5) H also agrees to
sell the remaining 25 percent of its share of the annual output to
numerous other private utilities under a prevailing rate schedule
including demand charges. (6) No contracts will be executed obligating
any person other than Z to purchase any specified amount of the power
for any specified period of time and no one such person (other than Z)
will pay a demand charge or other minimum payment under conditions
which, under paragraph (b)(5) of this section, result in a transfer of
the benefits of ownership and the burdens of paying the debt service on
obligations used directly or indirectly to provide such facilities. The
bonds are not industrial development bonds because H's one-third
interest in the facility (financed with bond proceeds) shall be treated
as a separate property interest and, although 25 percent of H's interest
in the annual output of the facility will be used directly or indirectly
in the trade or business of Z, a nonexempt person, under the rule of
paragraph (b)(5) of this section, such portion constitutes less than a
major portion of the subparagraph (5) output of the facility. If more
than 25 percent of the subparagraph (5) output of the facility were to
be sold to Z pursuant to the take or pay contract, the bonds would be
industrial development bonds since they would be secured by H's
ownership in the facility and revenues therefrom, and under the rules of
paragraph (b)(5) of this section a major portion of the proceeds of the
bond issue would be used in the trade or business of Z, a nonexempt
person.
Example (14). J, a political subdivision of a State, will issue
several series of bonds from time to time and will use the proceeds to
rehabilitate urban areas. More than 25 percent of the proceeds of each
issue will be used for
[[Page 360]]
the rehabilitation and construction of buildings which will be leased or
sold to nonexempt persons for use in their trades or businesses. There
is no limitation either on the number of issues or the aggregate amount
of bonds which may be outstanding. No group of bondholders has any legal
claim prior to any other bondholders or creditors with respect to
specific revenues of J, and there is no arrangement whereby revenues
from a particular project are paid into a trust or constructive trust,
or sinking fund, or are otherwise segregated or restricted for the
benefit of any group of bondholders. There is, however, an unconditional
obligation by J to pay the principal and interest on each issue of
bonds. Further, it is apparent that J requires the revenues from the
lease or sale of buildings to nonexempt persons in order to pay in full
the principal and interest on the bonds in question. The bonds are
industrial development bonds because a major portion of the proceeds
will be used in the trades or businesses of nonexempt persons and,
pursuant to an underlying arrangement, payment of the principal and
interest is, in major part, to be derived from payments in respect of
property or borrowed money used in the trades or businesses of nonexempt
persons.
Example (15). Power Authority K, a political subdivision created by
the legislature in State X to own and operate certain power generating
facilities, sells all of the power from its existing facilities to four
private utility systems under contracts executed in 1970, whereby such
four systems are required to take or pay for specified portions of the
total power output until the year 2000. Currently, existing facilities
supply all of the present needs of the four utility systems but their
future power requirements are expected to increase substantially. K
issues 20-year general obligation bonds to construct a large nuclear
generating facility. A fifth private utility system contracts with K to
take or pay for 30 percent of the subparagraph (5) output of the new
facility. The balance of the power output of the new facility will be
available for sale as required, but initially it is not anticipated
there will be any need for such power. The revenues from the contract
with the fifth private utility system will be sufficient to pay less
than 25 percent of the principal or interest on the bonds. The balance,
which will exceed 25 percent of the principal or interest on such bonds,
will be paid from revenues from the contracts with the four systems from
sale of power produced by the old facilities. The bonds will be
industrial development bonds because a major portion of the proceeds
will be used in the trade or business of a nonexempt person, and payment
of the principal and interest, pursuant to an underlying arrangement,
will be derived in major part from payments in respect of property used
in the trades or businesses of nonexempt persons.
(d) Certain refunding issues--(1) General rule. In the case of an
issue of obligations issued to refund the outstanding face amount of an
issue of obligations, the proceeds of the refunding issue will be
considered to be used for the purpose for which the proceeds of the
issue to be refunded were used. The rules of this subparagraph shall
apply regardless of the date of issuance of the issue to be refunded and
shall apply to refunding issues to be issued to refund prior refunding
issues.
(2) Obligations issued prior to effective date. In the case of an
issue of obligations issued to refund the outstanding face amount of an
issue of obligations issued on or before April 30, 1968 (or before
January 1, 1969, if the transitional rules of Sec. 1.103-12 are
applicable) which would have been industrial development bonds within
the meaning of section 103(c)(2) had they been issued after such date,
the refunding issue shall not be considered to be an issue of industrial
development bonds if it does not make funds available for any purpose
other than the debt service on the obligations. For rules as to
arbitrage bonds, see section 103(d).
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example (1). In 1969, State A issued $20 million of 20-year revenue
bonds the proceeds of which were used to contruct a sports facility
which qualifies as an exempt facility described in section 103(c)(4)(B)
and paragraph (c) of Sec. 1.103-8. The sports facility will be owned and
operated by X, a nonexempt person, for the use of the general public. In
1975, A issues $15 million of revenue bonds in order to refund the
outstanding face amount of the 1969 issue. Since the proceeds of the
1969 issue were used for an exempt facility, the proceeds of the 1975
refunding issue will be considered to be used for the same purposes and
section 103(c)(1) shall not apply to the 1975 refunding issue. The
result would have been the same if the original issue had been issued in
1965. For rules as to a refunding obligation held by substantial users
of facilities constructed with the proceeds of the issue refunded, see
section 103(c)(7) and Sec. 1.103-11.
Example (2). In 1967, prior to the effective date of section 103(c),
city B issued $10 million of revenue bonds the proceeds of which
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were used to construct a manufacturing facility for corporation Y, a
nonexempt person. Lease payments by Y were security for the bonds. In
1975, B issue $7 million of revenue bonds in order to retire the
outstanding face amount of the 1967 issue. The interest rate of the 1975
issue is one and one-half percentage points lower than the interest rate
on the 1967 issue. Both issues sold at par. All of the terms of the 1975
issue are the same as the terms of the 1967 issue with the exception of
the interest rate. The 1975 refunding issue will not be considered to be
an issue of industrial development bonds since the refunding issue will
not make funds available for any purpose other than the debt service on
the outstanding obligations.
Example (3). The facts are the same as in example (2) except that
the interest rate on the refunding issue is the same as the interest
rate on the issue to be refunded. Assume further that city B issued the
1975 refunding issue in order to extend the term of the obligations
issued in 1967 as the result of its inability to pay such obligations
due to insufficient revenues. The results will be the same as in example
(2) for the reasons stated therein.
[T.D. 7199, 37 FR 15486, Aug. 3, 1972; 37 FR 16177, Aug. 11, 1972, as
amended by T.D. 7869, 48 FR 1708, Jan. 14, 1983]