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May 27, 1981


The opinion of the court was delivered by: FULLAM


Section 103 of the Internal Revenue Code, 26 U.S.C. § 103, excludes from taxation as income, interest earned on obligations of states and municipalities; removes from this exemption interest earned on, inter alia, industrial development bonds; exempts from the latter exception certain "small issues" of industrial development bonds aggregating $ 1 million or less; and, finally, permits an increase of the amount of the "small issue" exemption to $ 5 million (now $ 10 million), under certain conditions. 26 U.S.C. § 103(b)(6) (D) (formerly § 103(c)(6)(D)). One who carefully threads his way through this labyrinth comes to the realization that the interest paid on industrial development bonds is exempt from taxation if the bonds come within the "small issue" exception. The ultimate question to be resolved in this case is whether certain bonds issued by the Redevelopment Authority of Philadelphia to plaintiff, the Continental Bank, qualify for the "small issue" exemption.


 On June 16, 1971, the Philadelphia Redevelopment Authority executed and delivered to Continental Bank an industrial redevelopment bond in the amount of $ 3 million. Continental advanced to the Authority the sum of $ 3 million in the form of a construction loan, which the Authority made available to Ronald Rubin & Co. Pursuant to an installment sale agreement, Rubin agreed to use the funds for the construction of a building at 4th and Market Streets in Philadelphia. Most of the proceeds of this transaction were used for purposes within the "small issue" exemption, but there is a dispute as to two items: a $ 100,000 real estate commission, and a $ 72,000 payment to an affiliate of the Rubin Company for supervising construction of the project.

 Eighteen months later, in December 1972, the Redevelopment Authority executed and delivered to Continental Bank a note for an additional $ 1 million, the proceeds of which were also made available to the Rubin firm. However, substantially all of the proceeds from this latter transaction were not used on the project, but for other purposes.

 In its tax returns, Continental Bank did not include as income the interest on these obligations. When the returns were audited, the IRS assessed a deficiency, contending that the interest was taxable. Plaintiff has paid the deficiency, and has brought this action to recover the alleged overpayment.

 Plaintiff now concedes that the interest on the $ 1 million note issued in December 1972 is taxable, but argues that the interest on the original $ 3 million issue is exempt. The Government argues for taxability of the interest in both cases, on the theory that the two transactions constitute a single "issue" of industrial redevelopment obligations; and that, since less than 90% of $ 4 million was spent for purposes permitted under the exemption, the exemption does not apply.

 The Treasury Department has issued three revenue rulings on the subject of whether multiple obligations constitute one or more "issues" under § 103(c). In Rev.Rul. 74-380, it was held that:

"Three bond issues on the same date pursuant to a single resolution adopted by a political subdivision of a state, to finance three distinctly different parts of a single manufacturing facility to be leased to an industrial corporation, will be considered three separate bond issues provided the security for each bond issuance is kept separate and distinct."

 InRev.Rul. 77-55, the Department ruled that:

"A state's issuance of industrial development bonds in 40 lots of $ 1 million each on the same day under a single bond indenture, all maintained under a single pooled security by a single trustee, is considered to be a single $ 40 million issuance that is not an exempt small issue under § 103(b)(6)(A) of the Code, and the interest is not excludable under § 103(a)(1)."

 And inRev.Rul. 78-159, it was stated:

"A state's simultaneous issuance of 25 separate series of industrial development bonds, each series to be issued in the amount of $ 1 million under a separate bond indenture with the security for each series independent of the proceeds or assets attributable to any of the other series issued concurrently, will be treated as 25 separate exempt small issues and interest on the bonds will be excludable from the gross incomes of the bondholders...."

 In the present case, the Authority issued $ 3 million in bonds, secured by a mortgage. Eighteen months later, the Authority borrowed an additional $ 1 million, against the same security. The $ 3 million transaction took the form of a 30-year bond; the later transaction took the form of a demand promissory note. Each was authorized by a separate resolution of the governing body of the Authority. At the time of the original transaction, none of the parties contemplated that additional borrowings would occur. Indeed, the earliest document mentioning a possible additional borrowing is dated in September 1972, some 15 months after the original transaction.

 The revenue rulings reviewed above all involved multiple transactions occurring on the same day. In two of the three cases, the multiple transactions were deemed to constitute a single "issue," but in the third they were not. Apparently, therefore, temporal proximity is a relevant, but not necessarily controlling, factor. More specifically, the fact that two related issues by the same issuer occurred on the same day does not necessarily require treatment as a single issue. These rulings do not, however, address the question whether lapse of time between the two transactions is sufficient, alone, to preclude a finding of a single, aggregate, issuance.

 The somewhat analagous regulations concerning arbitrage bonds do address this specific problem. Treasury Reg. § 1.103-13(b)(10) provides:

"(1) Issue: (i) Two or more obligations are part of the same "issue' ...

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