T.C. Memo. 1998-135
UNITED STATES TAX COURT
CITY OF COLUMBUS, OHIO, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3301-95B. Filed April 6, 1998.
David L. Miller and David A. Rogers, for petitioner.
Marsha A. Sabin, Sunita B. Lough, and Joel E. Helke, for
respondent.
SUPPLEMENTAL MEMORANDUM OPINION
TANNENWALD, Judge: This case is before the Court on remand
from the Court of Appeals for the District of Columbia Circuit in
City of Columbus v. Commissioner, 112 F.3d 1201 (D.C. Cir. 1997),
vacating and remanding 106 T.C. 325 (1996). The issue for
decision is whether the prepayment by petitioner of its
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indebtedness constitutes investment-type property under section
148(b)(2)(D).1
The findings of facts are set forth in our previous opinion,
City of Columbus v. Commissioner, 106 T.C. 325 (1996), and are
incorporated herein by this reference. We repeat only those
facts necessary to an understanding of the instant issue.
In 1965, the State of Ohio created a fully funded statewide
pension fund for police officers and firefighters (the State
fund) to replace the unfunded plans maintained by petitioner and
other Ohio municipalities. The State fund assumed and guaranteed
the pre-1967 pension liabilities of such municipalities,
including petitioner (the State fund obligation). State law
required each municipality to transfer its pension liabilities
and assets to the State fund and to pay the State fund, either
immediately or over time with interest, an amount equal to its
accrued unfunded pension liability. Petitioner transferred its
pension liabilities and assets on January 1, 1967, and chose to
pay its accrued unfunded pension liability over time (the city
obligation). Petitioner made scheduled payments until November
1993, when it entered into a prepayment agreement with the State
fund whereby petitioner paid the balance remaining on the city
obligation (the remaining obligation) in a lump-sum equal to 65
1
Unless otherwise indicated, all statutory references are
to the Internal Revenue Code, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
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percent of the outstanding principal balance (plus interest from
the time of the prepayment agreement until date of the lump-sum
payment). Petitioner made the lump-sum payment on January 31,
1994 (the prepayment).
Petitioner proposed to issue tax-exempt bonds to finance the
lump-sum payment and requested a ruling from respondent that the
interest on the proposed bonds would be exempt under section 103.
Respondent denied petitioner's request on the ground that such
bonds would be arbitrage bonds pursuant to section 148. In our
original opinion, we attributed the prepayment to the acquisition
of the State fund obligation in 1967, City of Columbus v.
Commissioner, 106 T.C. at 334, and concluded that the bonds would
be arbitrage bonds. The Court of Appeals reasoned that, if we
were correct in that attribution, the proposed bonds could not be
arbitrage bonds because the arbitrage provisions did not apply
retroactively to the 1967 transaction. City of Columbus v.
Commissioner, 112 F.3d at 1205-1206. The Court of Appeals
remanded the case and defined the scope of the remand as follows:
The purpose of § 148 is to prevent states and local
governments from using tax-exempt bond proceeds to
acquire higher yielding "investment property." Even if
a "prepayment for property" may itself be investment
property, it remains to be seen whether the City of
Columbus, by satisfying its obligation to the State
Fund in 1994, was making a "prepayment for property."
Before the anti-abuse regulations [sec. 1.148-10(e),
Income Tax Regs.] is considered, that question must be
resolved. [Id. at 1207.]
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It is clear that the threshold question is a narrow one:
Does the acquisition of one's indebtedness constitute an
acquisition of property so as to bring section 148 into play?2
It is petitioner's position that the prepayment extinguished
its indebtedness to the State fund and that it acquired no
property in that transaction. It is respondent's position that
petitioner's prepayment was investment-type property. Respondent
describes the result of petitioner's prepayment as "the city
received economic property through this investment use."
Respondent argues that to allow petitioner to issue tax-exempt
bonds contravenes the intent of section 148 through the use of a
vehicle similar to that of the prepayment for property or
services described in section 1.148-1(b), Income Tax Regs.
The purpose of section 148 is to prevent the use of tax-
exempt bonds to acquire higher-yielding investment property.
City of Columbus v. Commissioner, 112 F.3d at 1207; Conf. Rept.
99-841 (1986), 1986-3 C.B. (Vol. 4) 1, 747 ("the arbitrage
restrictions are expanded to apply to the acquisition of any
property held for investment other than another bond exempt from
tax under Code section 103."); sec. 1.148-10(a), Income Tax Regs.
Section 148(b)(2) defines investment property to include any
security, any obligation, any annuity contract, and any
2
We left this question aside in our original opinion, and
the Court of Appeals did likewise. City of Columbus v.
Commissioner, 106 T.C. 325, 334 (1996), revd. and remanded 112
F.3d 1201, 1205 (D.C. Cir. 1997).
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investment-type property. It is the scope of "investment-type
property" that is at issue herein. Section 1.148-1(b), Income
Tax Regs. states:
Investment-type property includes any property, other
than property described in section 148(b)(2)(A), (B),
(C), or (E), 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. * * *
Unquestionably, petitioner, by prepaying the remaining city
obligation, extinguished its preexisting debt. While petitioner
received an economic benefit from prepaying its debt, we do not
think it was paying for property. Petitioner purchased or
received nothing, beyond the State fund obligation it received
under the 1967 transaction, other than the discount for prepaying
its obligation to the State. Such discounts normally are
considered discharge of indebtedness income, not investments.
Sec. 61(a)(12); United States v. Kirby Lumber Co., 284 U.S. 1
(1931); Consolidated Edison Co. of New York, Inc. v. United
States, 10 F.3d 68 (2d Cir. 1993); Michaels v. Commissioner, 87
T.C. 1412, 1417 (1986) ("the discount here at issue was realized
by the prepayment, which is not considered a sale or exchange").
In cases where a purchase-money debt is owed to the seller, the
reduction generally is treated as a purchase price adjustment.
Sec. 108(e)(5); House v. Commissioner, T.C. Memo. 1995-92.
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Respondent seeks comfort from Consolidated Edison Co. of New
York, Inc. v. United States, supra. In that case, the taxpayer
prepaid real property taxes to New York City and received a
discount. It contended that the discount was tax-exempt
interest. The Court of Appeals for the Second Circuit rejected
that contention and held that the discount was includable in
gross income. The Court of Appeals then went on to hold that,
under the particular circumstances involved, the taxpayer was
entitled to deduct the full amount of the accrued taxes,
unreduced by the discount, on the ground that it utilized the
economic value of the discount to make the payments. There is
not the slightest indication by the Court of Appeals that it
considered the economic value of the discount as constituting
property, which is the issue involved herein. Such being the
case, and given the totally different circumstances involved
herein, we find respondent's reliance on Consolidated Edison Co
of New York, Inc. misplaced.
The long and short of the matter is that the discount
involved herein had economic value but that value cannot be
equated with property for which petitioner made the prepayment.
Consequently, we answer in the negative the threshold question
delineated by the remand.
Since there is no prepayment for property, we hold that the
prepayment in and of itself does not constitute investment-type
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property.3 Such being the case, petitioner's bonds are not
arbitrage bonds. Cf. California Health Facilities Authority v.
Commissioner, 90 T.C. 832, 843 (1988) (lending of bond proceeds
is not an "investment" with the result that such use does not
give rise to arbitrage).
Decision will be entered
for petitioner.
3
As the Court of Appeals for the District of Columbia
Circuit stated in City of Columbus v. Commissioner, 112 F.3d at
1205:
We also have no doubt that the 1994 transaction was a
"prepayment." But was the city's prepayment "for property"?
Only if it was may the prepayment itself be treated as
"investment-type property" under the regulation. * * *