106 T.C. No. 17
UNITED STATES TAX COURT
CITY OF COLUMBUS, OHIO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3301-95B. Filed May 14, 1996.
P, a home rule municipal corporation and political subdivision of the State of Ohio, seeks a declaratory judgment that interest on bonds it proposes to issue will be exempt from taxation under sec. 103(a), I.R.C. In 1967, in exchange for the assumption of P's accrued unfunded pension obligation by a fund established for that purpose by the State of Ohio, P incurred a long- term obligation to the State Fund. In 1994, P made a lump-sum payment equal to 65 percent of the remaining principal in satisfaction of the long-term obligation. Taking into account the 35-percent discount, the yield to P in making the prepayment, as compared to the payments it otherwise would have made, is 7.57484 percent. P proposes to issue long-term obligations, with an interest rate of 6 percent, to fund the prepayment to the State Fund. Pending our decision herein, P has issued short-term obligations to fund the prepayment. Held, P entered into the prepayment transaction with a principal purpose being to profit from the discount offered by the State Fund. Held, further, to reflect the economic substance of the transaction, R may characterize the prepayment as the acquisition of property. Sec. 1.148-10(e), Income Tax Regs. Held, further, the prepayment constitutes investment-type property, sec. 148(b)(2), I.R.C., with a materially higher yield than the proposed bonds. Thus, interest on the proposed bonds will not be excludable from gross income under sec. 103(a), I.R.C.
David L. Miller, Jerry O. Allen, and David A. Rogers, for
petitioner.
Rebecca L. Caldwell-Harrigal, Joel E. Helke, and Richard L.
Carlisle, for respondent.
OPINION
TANNENWALD, Judge: This is an action for a declaratory
judgment pursuant to section 7478 and Rule 211.1 On June 3,
1994, petitioner submitted a ruling request to respondent seeking
a determination that interest on certain proposed bonds will be
excludable from gross income under section 103(a). After
administrative review, on December 5, 1994, respondent ruled that
interest on the proposed bonds will not be excludable under
section 103(a) on the grounds that the bonds would be arbitrage
and/or hedge bonds within the meaning of sections 148 and 149(g),
respectively. All of the jurisdictional requirements for a
declaratory judgment action have been satisfied. Rule 210(c).
All statutory references are to the Internal Revenue Code, and all Rule references are to the Tax Court Rules of Practice and Procedure. Petitioner bears the burden of proof. Rule 217(c)(2)(A). Our
decision is based upon the stipulated administrative record,
which is incorporated herein by this reference, and additional
evidence received pursuant to an Order of this Court. Rule
217(a).2
Petitioner is the City of Columbus, Ohio (City). On
December 20, 1993, the City Council of Columbus adopted an
ordinance authorizing the issuance of bonds in a principal amount
not to exceed $28 million. In its ruling request, petitioner
anticipated the actual amount of the proposed bonds would be
$27,300,000. Having retired $600,000 in principal amount of its
1994 bond anticipation notes (see infra p. 8), petitioner now
anticipates the actual amount of the proposed bonds will be
$26,700,000.
Petitioner is a home rule municipal corporation and
political subdivision of the State of Ohio (State). Before 1967,
the City maintained two pension funds for its police officers and
firefighters (collectively referred to hereinafter as the City
Fund).
In 1965, a State law was enacted creating the Police and
Firemen's Disability and Pension Fund (the State Fund), a
Respondent objects to what she describes as petitioner's attempt to admit additional material into evidence, by way of Appendices A and B to petitioner's opening brief. Appendix A contains an amortization of the City Obligation based on an exhibit in the stipulated record and is thus not new evidence. Appendix B, however, is an amortization schedule of the proposed bonds and is new evidence as to which we sustain respondent's objection. - 4 -
statewide pension fund for police officers and firefighters. The
State Fund was created to replace unfunded plans of the City and
other municipalities with a fully funded pension plan. The State
Fund assumed and guaranteed the pre-1967 pension liabilities of
Ohio municipalities, including the City (the State Fund
Obligation). In addition, the State law provided that pension
liabilities for police officers and firefighters accruing on and
after January 1, 1967, would be supported by current employer and
employee contributions.
Pursuant to the State law, the value of the transferred
liabilities and assets of each municipality was determined by The
Wyatt Company (Wyatt), an actuarial company employed by the State
to make the calculations. Wyatt computed the present value of
each municipality's accrued unfunded pension liability, using a
discount factor of 4.25 percent, compounded annually (the
mathematical equivalent of 4.21 percent compounded semiannually),
and certain actuarial assumptions based on mortality tables.
Wyatt determined the present value of the accrued unfunded
liabilities of the City Fund that were transferred to the State
Fund, to be $44,638,971. Of that amount, $1,929,702 was
satisfied by assets of the City Fund, and the City was credited
with $21,470 of accrued interest, resulting in a net accrued
liability of $42,687,799. - 5 -
On January 1, 1967, as required by the law creating the
State Fund, the liabilities and assets of the City Fund were
transferred to the State Fund.
The State law required each municipality to pay to the State
Fund, either immediately or over time with interest, an amount
equal to its accrued unfunded pension liability, i.e., the
difference between the transferred liabilities and assets. If a
municipality opted to pay that amount over time, the State law,
as originally enacted, required it to pay interest at 4 percent
per annum on the unpaid balance. Subsequent to an amendment to
the State law in 1968, the interest rate charged by the State
Fund has been 4.25 percent per annum.
Petitioner chose to pay the present value of its accrued
unfunded pension liability over time (the City Obligation). It
has never been obligated to make up for any shortfalls or
deviations from the actuarial calculation of its accrued unfunded
pension liability.
The deferred payment option in the original State law
required any amount unpaid as of January 1, 1968, to be paid over
20 years in equal principal installments, i.e., at least 5
percent of the amount unpaid as of January 1, 1968, each year),
together with interest at 4 percent. Principal and interest on
the obligation were payable semiannually on dates to be
determined by the trustees of the State Fund. By State law, - 6 -
effective November 25, 1969, the unpaid City Obligation, as of
January 1, 1969, was to be paid 2 percent in 1969, 2 percent in
1970, 3 percent in 1971, 4 percent in 1972, and 5 percent per
annum beginning in 1973 and each year thereafter for 62 years.
This repayment schedule incorporated the payment of interest at a
rate of 4.25 percent, compounded semiannually. The City made
payments pursuant to the above schedule through 1993.
Under the State Fund pension system, both municipal
corporations and their employees who are police officers and
firefighters contribute a percentage of current wages to the
State Fund. The State Fund pays pensions in defined amounts to
retired police officers, firefighters, and surviving spouses and
dependents. It treats all participating municipal corporations
and their police officers and firefighters equally based on
current contributions. No consideration is given as to whether a
particular municipal corporation paid the principal amount of its
accrued unfunded pension liability in full or agreed to pay such
liability over time. Amounts in the State Fund are invested for
the equal benefit of all police officers and firefighters
throughout the State. The actuary for the State Fund has assumed
a rate of return on investments of the State Fund of 8.25
percent, compounded annually.
Approximately 304 municipalities transferred their assets
and accrued liabilities as of January 1, 1967, to the State Fund. - 7 -
In 1993, section 742.30(C) was added to the Ohio Revised
Code which provided:
(C) The board of trustees of the police and firemen's disability and pension fund may enter into an agreement with a municipal corporation for a single payment by the municipal corporation of the employer's accrued liability. The agreement may provide for a reduction in the amount of the accrued liability based on the value to the fund of receiving a single payment. A municipal corporation that has made payment in accordance with such an agreement shall have no further obligation to make payments under this section. [Ohio Rev. Code Ann. sec. 742.30(C) (Anderson Supp. 1995).]
Pursuant to this provision, the State Fund allowed single,
lump-sum payments, beginning October 20, 1993. The State Fund
adopted 65 percent of the outstanding principal balance as the
discounted amount it would accept for such a payment.
From October 20, 1993, to December 14, 1995, 36
municipalities, including the City, made a lump-sum payment, in
exchange for release of the full amount of their outstanding
liability to the State Fund.
On November 3, 1993, the City entered into a prepayment
agreement with the State Fund. On November 15, 1993, the
outstanding principal balance of the City Obligation was
$41,435,720, which amount was still to be paid periodically until
2035. Under the agreement, the City agreed to pay a lump sum of
$26,933,218, following which it would have no further obligation
to the State Fund. The City was obligated to make the lump-sum - 8 -
payment within 90 days of November 3, 1993, and was required to
pay interest at a rate of 4.25 percent per annum from
November 15, 1993, until the payment was made. The City made the
payment of $27,304,720 to the State Fund on January 31, 1994,
including interest of $371,502.
If the 35-percent discount is taken into account, the yield
to petitioner for prepaying the City Obligation, as compared to
the payments it otherwise would have made, is 7.57484 percent.
It was commercially reasonable for the City to finance the
lump-sum payment by issuing obligations carrying a taxable
interest rate. However, petitioner initially contemplated
issuing tax-exempt bonds. After discussions with respondent, and
before issuing long-term bonds, petitioner decided to obtain a
private letter ruling from respondent on whether interest on the
bonds would be excludable from gross income under section 103.
On January 31, 1994, the City issued $27,300,000 in 1-year
bond anticipation notes (BAN's), due January 31, 1995. The BAN's
sold for $27,334,125 and were general obligations of the City.
On January 31, 1994, the City transferred $27,304,720 of the BAN
proceeds to the State Fund in satisfaction of the lump-sum
payment agreement.
Upon the maturity of the 1994 BAN's, petitioner, having
repaid $600,000 of the 1994 BAN's, refinanced the remaining
$26,700,000 with an issue of BAN's in that amount, maturing - 9 -
January 30, 1996 (the 1995 BAN's). All 1995 BAN proceeds were
expended on January 31, 1995, to discharge the 1994 BAN's.
Petitioner intends to continue to refinance the 1995 BAN's
with short-term BAN's until there is a final court determination
in this matter.3
Petitioner proposes to issue the proposed bonds either on a
tax-exempt or taxable basis, depending on the final determination
in this proceeding, and immediately utilize all proceeds of the
bonds to discharge the then-outstanding BAN's and pay related
expenses on the issue of the proposed bonds. Petitioner
represents that the proposed bonds will be long-term obligations
but did not, in its ruling request or otherwise (until its
original brief, see supra note 2), set forth any terms of payment
of principal. For purposes of its ruling request, petitioner
represented that the proposed bonds would be long-term
obligations, with a term of 25 years or less, and that the yield
should be assumed to be 6 percent compounded semiannually.
Section 103(a) generally excludes interest on State and
local government bonds from taxable income. The exclusion is
The BAN's have been issued on the basis that the interest thereon was not excludable under sec. 103(a). Petitioner has, however, sought to preserve the possible tax-exempt status of such interest by filing Internal Revenue Service Form 8038-G in respect of the 1994 and 1995 BAN's and Internal Revenue Service Form 8038-T, along with an arbitrage rebate payment in respect of the 1994 BAN's based on the differential between the 4.25-percent interest rate on the City obligation and the yield on such BAN's. - 10 -
inapplicable to any arbitrage bond within the meaning of section
148. Sec. 103(b).
An arbitrage bond is defined in section 148(a) as follows:
(a) Arbitrage Bond Defined.--For purposes of section 103, the term "arbitrage bond" means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly--
(1) to acquire higher yielding investments * * *
For purposes of this subsection, a bond shall be treated as an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described in paragraph (1) * * *.
A higher yielding investment is "any investment property
which produces a yield over the term of the issue which is
materially higher than the yield on the issue." Sec. 148(b)(1).
Section 148(b)(2) provides in pertinent part:
(2) Investment property.--The term "investment property" means--
(A) any security (within the meaning of section 165(g)(2)(A) or (B)),
(B) any obligation,
(C) any annuity contract,
(D) any investment-type property * * *
The legislative purpose in enacting these provisions is
reflected in the following statement in the report of the House - 11 -
Ways and Means Committee at the time section 148 was enacted in
1986:
The bill also provides additional restrictions on the types of obligations in which bond proceeds may be invested without regard to yield restrictions. Under the bill, the arbitrage restrictions are expanded to apply to the acquisition of any property held for investment other than another bond exempt from tax under the Code. Thus, investment in any taxable security as well as any deferred payment contract (e.g., an annuity) or other property held for investment is precluded if the yield on the property is materially higher than the yield on the bonds. This restriction applies regardless of the purpose of the investment (e.g., whether the investment is acquired as an acquired purpose obligation, an acquired nonpurpose obligation, or an acquired program obligation). Under this rule, for example, the purchase of an annuity contract to fund a pension plan of a qualified governmental unit would be subject to the same arbitrage restrictions as would direct funding of that plan with bond proceeds. The purchase of bond insurance is not considered to be the purchase of an annuity contract. Similarly, investment of bond proceeds in any other type of deferred payment investment-type contract to fund an obligation of the issuer or bond beneficiary would be subject to these yield restrictions. The restriction would not apply, however, to real or tangible personal property acquired with bond proceeds for reasons other than investment (e.g., courthouse facilities financed with bond proceeds). [H. Rept. 99-426 (1985), 1986-3 C.B. (Vol. 2) 1, 552; fn. ref. omitted; emphasis added.]
Almost the same statement appears in the report of the Senate
Finance Committee. S. Rept. 99-313 (1985), 1986-3 C.B. (Vol. 3)
1, 845; see also H. Conf. Rept. 99-841 (1986), 1986-3 C.B. (Vol.
4) 1, 747.
Investment-type property is defined in section 1.148-1(b),
Income Tax Regs., in pertinent part, as follows: - 12 -
Investment-type property includes any property, other than property described in section 148(b)(2)(A), (B), (C), * * * that is held principally as a passive vehicle for the production of income. Except as otherwise provided, a prepayment for property or services is investment-type property if a principal purpose for prepaying is to receive an investment return from the time the prepayment is made until the time payment otherwise would be made. A prepayment is not investment-type property if--
(1) The prepayment is made for a substantial business purpose other than investment return and the issuer has no commercially reasonable alternative to the prepayment, or
(2) Prepayments on substantially the same terms are made by a substantial percentage of persons who are similarly situated to the issuer but who are not beneficiaries of tax-exempt financing.
The parties have presented us with a welter of arguments
many of which are devoted to a semantical analysis of the
foregoing statutory provision and of other provisions of the
regulations under sections 148 and 150 dealing with the extent to
which the regulations in respect of the refunding of prior issues
apply to the proposed bond issue and the BAN's. In particular,
petitioner argues that the proposed bonds constitute a refunding
issue of the BAN's and through them of the City Obligation and
that the specific tracing methods of the regulations4 preempt any
prepayment analysis. Respondent agrees that the proposed bonds
are a refunding issue of the BAN's, so that we may treat the
See secs. 1.148-9, 1.150-1(d)(1), (5), Income Tax Regs. - 13 -
proposed bonds as if the funds raised therefrom were utilized
directly in 1994. As to petitioner's characterization of the
City Obligation, petitioner fails to accord adequate recognition
to the broad authority given to the Secretary to issue
regulations implementing section 148. Thus, section 148(i)
provides:
(i) Regulations.--The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.
The breadth of this authority to issue "legislative"
regulations, see Coca-Cola Co. & Subs. v. Commissioner, 106 T.C.
1, 18-19 (1996), is clearly revealed by the following statement
in the report of the House Ways and Means Committee at the time
of the enactment of the Technical and Miscellaneous Revenue Act
of 1988, Pub. L. 100-647, sec. 1013(a)(34)(A), 102 Stat. 3342,
3544:
The bill further deletes and re-inserts the term "necessary" in the specific regulatory authority granted the Treasury Department under the arbitrage restrictions. This amendment is intended to clarify that Treasury's regulatory authority is to be interpreted broadly, rather than in a literal, dictionary manner * * *. That regulatory authority is intended to permit Treasury to eliminate any devices designed to promote issuance of bonds either partially or wholly as investment conduits in violation of the provisions adopted by Congress to control such activities and to limit the issuance of tax-exempt bonds to amounts actually required to fund the activities for which their use specifically has been approved by Congress. Further, that regulatory authority is intended to permit Treasury to adopt rules (including allocation, accounting, and replacement - 14 -
rules) necessary or appropriate to accomplish the purpose of the arbitrage restrictions, which is to eliminate significant arbitrage incentives to issue more bonds, to issue bonds earlier, or to leave bonds outstanding longer. [H. Rept. 100-795 at 327-328 (1988).]
In accordance with the authority, section 1.148-10(e),
Income Tax Regs., provides:
(e) Authority of the Commissioner to clearly reflect the economic substance of a transaction. If an issuer enters into a transaction for a principal purpose of obtaining a material financial advantage based on the difference between tax-exempt and taxable interest rates in a manner that is inconsistent with the purposes of section 148, the Commissioner may exercise her discretion to depart from the rules of § 1.148-1 through § 1.148-11 as necessary to clearly reflect the economic substance of the transaction. For this purpose, the Commissioner may recompute yield on an issue or on investments, reallocate payments and receipts on investments, recompute the rebate amount on an issue, or otherwise adjust any item whatsoever bearing upon the investments and expenditures of gross proceeds of an issue.
Petitioner makes much of the fact that it is prepared to
issue the proposed bonds on the basis of the interest thereon
being taxable, i.e., not exempt under section 103(a). Such being
the case, petitioner argues that the prepayment did not have "a
principal purpose * * * to receive an investment return" within
the meaning of section 1.148-1(b) or 1.148-10(e), Income Tax
Regs. Consequently, petitioner asserts that the question of
"yield" becomes irrelevant in determining whether the proposed
bonds are arbitrage bonds. We disagree. - 15 -
There is no question that petitioner's purpose in prepaying
the City Obligation was to profit from the discount offered by
the State Fund.5 The fact that it would profit from the discount
if the interest on the proposed bonds were taxable does not
negate the fact that such profit would be greater if such
interest was exempt from tax under section 103(a). Nor does the
fact that the issuance of taxable bonds would also be
advantageous turn the purpose of the proposed issue on a
nontaxable basis from a principal to a subsidiary purpose. Such
a view would emasculate the arbitrage restrictions of section 148
whenever a financial advantage of a bond issue could be obtained
whether the interest on the bonds was taxable or nontaxable. In
this connection, we think it significant that the regulation
speaks in terms of "a" and not "the" principal purpose. Santa Fe
Pacific v. Central States Pension Fund, 22 F.3d 725, 727 (7th
Cir. 1994).
In its application for the ruling, petitioner stated:
[O]ne of the principal governmental purposes for issuing the BANs, and for issuing the Proposed Bonds * * * was to achieve an economic benefit represented by a present value debt service savings with respect to the City Obligation. That debt service savings was made possible in part because of the ability of the City to pay off the City Obligation at the amount provided for in the Payoff Agreement, i.e. 65% of the principal balance of the City's employer's accrued liability, plus accrued interest through January 31, 1994 at 4.25%. - 16 -
Two key requirements for the application of the arbitrage
provisions of section 148 are that there must be an acquisition
of investment property, which produces a materially higher yield.
Sec. 148(a) and (b), supra p. 10. We turn first to the question
of whether the prepayment was used to acquire investment
property. Petitioner argues initially that, at no time, was
there any acquisition of investment property because, in 1967,
there was simply an exchange of liabilities, i.e., the obligation
of the City Fund for the obligation of the State Fund. This
position is utterly without merit. The obligation of the State
Fund was clearly property in the hands of the City and was a
specific type of property that Congress had in mind, i.e., the
equivalent of a funding of the pension obligation of the City.
See supra p. 11.
Petitioner goes on to argue that, at the time of the
prepayment in 1994, the City was doing nothing more than
discharging the City Obligation and that one does not acquire
property when it acquires its own indebtedness. Leaving aside
the question whether the acquisition of one's own indebtedness
constitutes the acquisition of "property", we think petitioner
overstates the proposition in the context of the situation
herein. The City Obligation represented the payment for the
obligation of the State Fund in 1967, and we think that nexus
remained extant at the time of the 1994 prepayment. In short, - 17 -
the source to which the prepayment applied was the acquisition of
the obligation of the State Fund and controls the character of
the transaction. Cf. Woodward v. Commissioner, 397 U.S. 572
(1970) (articulating the "origin of the claim" test). Thus, we
conclude that the prepayment was for property and consequently we
turn to the question whether it was "investment property". On
this point, the parties have locked horns on whether the
prepayment falls within the ambit of "investment-type property"
within the meaning of section 1.148-1(b), Income Tax Regs., supra
p. 12.
Petitioner argues that the prepayment is not investment-type
property because it satisfies the latter of the two exceptions in
the regulations, namely a prepayment is not investment-type
property if prepayments on substantially the same terms are made
by a substantial percentage of persons who are similarly situated
but who are not beneficiaries of tax-exempt financing. The
regulation does not define a substantial percentage.
As of October 20, 1993, when the State Fund offered the
discount for prepayment, there were 224 municipalities with
obligations to the State Fund. As of December 14, 1995, 36
municipalities had prepaid at the 35-percent discount. It is
represented that none of the 35 municipalities, excluding
petitioner, utilized the benefit of tax-exempt financing with
respect to their prepayments. In sum, 36 of 224 municipalities, - 18 -
or 16.07 percent, made a prepayment on substantially similar
terms.
Petitioner cites various instances where the term
"substantial" refers to percentages of 5 to 15 percent, including
section 1.103-11(b), Income Tax Regs. (5 percent); section 1.148-
2(e)(2)(B), Income Tax Regs. (5 percent); section 6662(d)(1) (10
percent); and section 147(c)(2)(E) (15 percent). Elsewhere, the
term refers to percentages as high as 25 percent, section
42(d)(2)(D)(i)(III); section 6229(c)(2), and 33 percent, section
382(l)(4)(B)(i).
Clearly, the term "substantial" can cover a wide range of
values.6 Where Congress meant only to allow customary
prepayments, we do not find that 16.07 percent is a substantial
percentage. Thus, the prepayment herein does not satisfy the
exception, and the prepayment of the City Obligation with the
proceeds of the BAN's constitutes the acquisition of investment-
type property. Moreover, we are not convinced that Congress
intended that the exception should apply where, as is the case
herein, the only offerees of the prepayment opportunity were
entities who were beneficiaries of tax-exempt financing rather
than to a class of offerees that included some of these
beneficiaries. If this were the standard for the application of
See Nabisco Brands, Inc. v. Commissioner, T.C. Memo. 1995-127 at n.22. - 19 -
the exception, the number of persons who took advantage of the
prepayment terms would appear to be irrelevant.
Having decided that petitioner is not entitled to the
benefits of the exception in section 1.148-1(b), Income Tax
Regs.,7 we are left with the issue whether the prepayment
produced a materially higher yield than the proposed bonds. Sec.
148(b)(1).
Respondent argues that, by virtue of the discount
arrangement with the State Fund, the City should be treated as
sharing in the investment yield of that fund, the rate of yield
being 8.25 percent. Petitioner argues that the City and the
State Fund are separate entities and that such "sharing" implies
a partnership or combined entity which has no legal
justification. We agree with petitioner on this point. There is
no doubt that the high rate of yield anticipated by the State
Fund was the foundation of the discount arrangement and no doubt
entered into the determination of the amount of the discount
which the State Fund decided to offer. But it does not follow
that this circumstance justifies the conclusion that the City had
an ongoing share in the investment yield of the State Fund. Our
No inference should be drawn that we would have ruled in favor of petitioner if the exception did apply. Under such circumstances, we would still have to decide whether respondent should still prevail because of the broad discretionary authority conferred upon her by sec. 1.148-10(e), Income Tax Regs., supra p. 14. - 20 -
rejection of respondent's yield argument does not, however, end
our inquiry.
Petitioner concedes that, if the discount is taken into
account, the yield is 7.57484 percent, which is more than
sufficient to constitute a materially higher yield than the 6
percent yield on the proposed bonds.8 Petitioner contends,
however, that the discount should not be taken into account and
that the proper yield for purposes of comparison is the 4.25-
percent interest rate on the City Obligation. We disagree. If
the discount is not taken into account, one is faced with a most
peculiar situation, namely, a borrowing at 6-percent interest to
pay off an obligation bearing 4.25-percent interest. It is only
because of the discount that the prepayment and the financing
thereof at a 6-percent interest rate make any sense. Indeed,
that is the clear foundation of the transactions and the
substantive justification for the prepayment.
In sum, we hold that, however one views the transactions
involved herein, a principal purpose of the City was to replace
the City Obligation with a payment for an investment in the State
A materially higher yield, with exceptions not applicable herein, is a yield one-eighth of 1 percentage point greater than that of the issue in question. Sec. 1.148-2(d)(2), Income Tax Regs.; Staff of the Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, at 1201-1202 (J. Comm. Print 1987). - 21 -
Fund's obligation to finance the City's original unfunded pension
obligations in a manner which produces the equivalent of a
7.57484-percent return, i.e., yield, on such investment. Under
the circumstances herein, irrespective of the technicalities of
the arbitrage regulations under section 148, respondent was
entitled to make the adjustment of the yield calculation to take
the 35-percent discount into account and to reject petitioner's
application for ruling under section 1.148-10(e), Income Tax
Regs., on the ground that the economic substance of the
transaction clearly revealed a materially higher yield within the
meaning of section 148(a) and (b) and the regulations thereunder.
Consequently, the interest on the proposed bonds will not be
exempt under section 103(a).
In view of the foregoing, we find it unnecessary to consider
the other arguments of the parties.
Decision will be entered
for respondent.