State v. Comm'r of Internal Revenue , Docket No. 16153-79B.
| Decision Date | 24 September 1981 |
| Docket Number | Docket No. 16153-79B. |
| Citation | 77 T.C. 656 |
| Parties | STATE of WASHINGTON, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner seeks a declaratory judgment that bonds it proposes to issue will be exempt from taxation under sec. 103(a), I.R.C. 1954, and not arbitrage bonds as defined in sec. 103(c). Petitioner intends to invest the proceeds from these bonds in U.S. Government securities which offer a yield to petitioner not in excess of the yield which its bonds will produce, but only if the yield on petitioner's bonds is computed by taking into account petitioner's issuing expenses including underwriter's spread. Held, petitioner's method of computing the “yield” on its proposed bonds is sustained. Held, further, certain portions of sec. 1.103-13(d), Income Tax Regs., are invalid. Held, further, petitioner's proposed bonds will not be arbitrage bonds within the meaning of sec. 103(c). C. Willis Ritter and Walter D. Haynes, for the petitioner.
Charles W. Rumph and Elizabeth D. DePriest, for the respondent.
This is an action for a declaratory judgment pursuant to section 7478. 1 On March 1, 1979, petitioner submitted a ruling request to respondent following the procedures set forth in Rev. Proc. 79-4, 1979-1 C.B. 483. Petitioner requested respondent to rule that the general obligation refunding bonds it proposed to issue are not “arbitrage bonds” within the meaning of section 103(c) and that the interest paid by petitioner to the holders of such bonds would be exempt from Federal income tax pursuant to section 103(a). After a lengthy administrative review, respondent denied petitioner's request.
All of the jurisdictional requirements for a declaratory judgment have been satisfied. See Rule 210(c), Tax Court Rules of Practice and Procedure. The burden of proof is upon petitioner. See Rule 217(c)(2)(i), Tax Court Rules of Practice and Procedure. Our decision is based upon the administrative record. See Rule 217(a), Tax Court Rules of Practice and Procedure. For the reasons set forth below, we hold for petitioner.
On April 21, 1971, petitioner issued its public school building revenue bonds, series C (the outstanding bonds) to finance the construction of public schools. The outstanding bonds bear interest rates ranging from 8 percent to 6 percent payable semiannually on May 1 and November 1 and mature annually on May 1 of each year through 2001. On the date of petitioner's ruling request, there were $19,880,000 outstanding bonds as follows:
The outstanding bonds maturing on or after May 1, 1987, may be called for redemption by petitioner without penalty on November 1, 1986. On that date, there will be $16,205,000 in outstanding bonds. On the date of petitioner's ruling request, the semiannual debt service on the $19,880,000 outstanding bonds through and including the redemption of the $16,205,000 in bonds remaining on November 1, 1986, was as follows:
The outstanding bonds are limited obligations of the State of Washington, payable only from specifically identified revenues of certain trust funds pledged therefor. Because the outstanding bonds are not general obligations of the State, their credit rating is lower and their interest rates are higher than they would be were they issued as general obligation bonds. In addition, the State is required to fund and maintain a reserve account for the outstanding bonds in an amount equal to at least 2 times the maximum amount of principal and interest payable on the outstanding bonds in any year. A total of approximately $5 million has been accumulated in the reserve account and other accounts for eventual payment of debt service on the outstanding bonds. Section 10 of the 1971 resolution of the State authorizing the issuance of the outstanding bonds provides that if money and direct obligations of the United States sufficient to redeem the outstanding bonds are irrevocably set aside in a principal and interest account for the outstanding bonds, then the lien of the outstanding bonds against the funds and revenues pledged to the payment of the outstanding bonds shall be released.
Following issuance of the outstanding bonds, the State of Washington constitution was amended to authorize the State to pledge its full faith, credit, and taxing power to the payment of debt service on new bonds which otherwise would be payable only from the limited revenues pledged to the outstanding bonds. Because of the higher credit rating assigned to bonds backed by the full faith and credit of the State, petitioner expects that bonds issued to refund the outstanding bonds will bear lower interest rates than the outstanding bonds. Furthermore, since general obligation bonds of the State need not be secured by reserve accounts, the State can apply the $5 million of funds accumulated for the outstanding bonds to reduce the principal amount of refunding bonds required to refund the outstanding bonds. Petitioner therefore intends to issue approximately $15,160,000 general obligation bonds in order to refund the limited obligation outstanding bonds.
Pursuant to authority vested in it, the State of Washington finance committee on December 5, 1978, adopted a resolution authorizing the issuance of “State of Washington General Obligation Refunding Bonds, Series D” (the refunding bonds) in the principal amount of $15,200,000, or such greater or lesser amount as may be required to comply with the requirements of section 103(c). In its ruling request, petitioner anticipated that the actual amount of bonds sold would be $15,160,000.
The refunding bonds will be sold by petitioner at public sale pursuant to the official notice of bond sale which requests that sealed bids be submitted to petitioner. Refunding bonds will be awarded to the bidder whose offer, taking into account both the coupon rate and the price to be received by petitioner, represents the lowest net cost to petitioner. The purchaser will acquire ownership of the refunding bonds for its own account and not as a broker or agent for petitioner. Petitioner anticipates that the refunding bonds will be sold to the lowest bidder at 98.5 percent of par. However, petitioner also anticipates that the refunding bonds will be resold to the public at 100 percent of par, although the purchaser of the refunding bonds will not be obligated to resell them. Petitioner has often sold bonds in this manner.
The proposed refunding bonds will bear coupon rates ranging from 43 3/4 percent to 5 5/8 percent. With these coupon rates and a purchase price of 98.5 percent of par, the principal amount of refunding bonds actually awarded to the lowest bidder would be $15,160,000. The debt service on such refunding bonds as compared to the debt service on the outstanding bonds absent the refunding (and therefore absent early redemption) is as follows:
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