Court Opinion

ID: 4472710
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:34:52.064845+00
Date Added: 2024-06-11T07:54:30.882648
License: Public Domain

Jacobs, J., dissenting: The majority opinion is premised on the notion that section 148(f) is unambiguous, thus preventing us from looking beyond the words of the statute. In my opinion, the majority’s mechanical interpretation of section 148(f), when applied to the unusual facts of this case,1 leads to a result that does not comport with the rationale behind the promulgation of the arbitrage provisions. See Birdwell v. Skeen, 983 F.2d 1332, 1337 (5th Cir. 1993); Wilshire Westwood Associates v. Atlantic Richfield Corp., 881 F.2d 801, 804 (9th Cir. 1989). Accordingly, I believe that we should resort to the legislative history for aid in applying section 148(f) to the facts of this case. By doing so, I conclude, as petitioners do, that Congress did not intend to make the issuers of tax-exempt bonds (here, the Housing Authority of Riverside County, California) the insurers for wrongful actions of those who misuse the bond proceeds to earn arbitrage profits for themselves. Accordingly, I would hold that the bonds issued by the housing authority are not arbitrage bonds. I would further hold that the bonds are nontaxable industrial development bonds.2 Ultimately, I would hold that the interest on the bonds is excludable from gross income under section 103(a). Section 103(a) provides that a taxpayer’s gross income does not include interest earned on the obligations of a State or a political subdivision of a State. This exemption has been a feature of the Internal Revenue Code ever since the Federal income tax was adopted in 1913. S. Rept. 91-552, at 219 (1969), 1969-3 C.B. 423, 562. The purpose of this exemption is to assist State and local governments by allowing them to issue marketable bonds at interest rates below those of corporate and Federal securities. See, e.g., Washington v. Commissioner, 77 T.C. 656 (1981), affd. 692 F.2d 128 (D.C. Cir. 1982); 113 Cong. Rec. 31,611 (daily ed. Nov. 8, 1967) (statement of Senator Ribicoff). Having been the trial Judge,3 I had the opportunity to observe William Rosenberger (executive director of the housing authority and the person charged with responsibility for the issuance of the bonds) testify. I am convinced that he, as well as the other housing authority officials, reasonably expected that the bond proceeds would be used for the construction of housing for low-to-moderate-income families and that the Gic’s would be held by the mcfc companies as unrelated guarantors of the bond payments. I am further convinced that at no relevant time did he or other housing authority officials have any reason to suspect that Unified and the MCFC companies would divert the bond proceeds from the construction of housing to the purchase of Gic’s, which in turn would be used to pay the debt service on the bonds.4  The housing authority did not benefit from the misuse of the bond proceeds. The majority, however, would attribute the shenanigans of the wrongdoers to the housing authority; I would not. The development of the arbitrage provisions shows that Congress sought to prevent States and their subdivisions from misusing their tax-exempt privileges by issuing low-yielding bonds and thereafter investing the bond proceeds into higher-yielding instruments. There is no indication that Congress would require State or local governments to rebate amounts that they never authorized or received. In 1969, when Congress enacted the section 103 provisions removing arbitrage bonds from tax-exempt status, the Senate Finance Committee explained that it did so to ensure that the Federal Government does not become “an unintended source of revenue for State and local governments”. S. Rept. 91-522, supra at 219, 1969-3 C.B. at 562. Concerns later developed, however, that unwary purchasers of tax-exempt bonds might be taxed upon the interest received if the issuer subsequently used the proceeds for arbitrage revenue. At a congressional hearing in 1978, Assistant Secretary Lubick was asked whether the Commissioner could change his mind about the nonarbitrage status of a bond after it was issued. Mr. Lubick replied: “That is a determination which is made as of the issuance date. The fact that the [issuer] goes oh and does something different from what it proposed originally does not change the status of the bond. This determination is made ab initio.” Revenue Act of 1978: Hearings on H.R. 13511 before the Senate Comm. on Finance, 95th Cong., 2d Sess. 958-959 (1978). In 1984, Congress reviewed the various remaining provisions that permitted States to collect arbitrage and noted: “Present rules permit issuers to retain any arbitrage earned under these rules”. H. Conf. Rept. 98-861, at 1205 (1984), 1984-3 C.B. (Vol. 2) 1, 459 (emphasis supplied). Congress therefore made the rebate provisions applicable to certain industrial development bonds and to certain student loan bonds. Sec. 103(c)(6), as added by Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 624(a), 98 Stat. 922. In the Tax Reform Act of 1986, Congress decided to extend the rebate requirements to additional classes of tax-exempt bonds, including those issued to provide multifamily residential housing.5 See Tax Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 1314(d), 100 Stat. 2664. With this change came new rules relating to the computation of the rebate. The amount to be rebated is determined by first finding the amount earned on “nonpurpose investments”. These earnings then are compared to the amount that would be yielded at the bond issue’s rate of interest. For such purposes, the Commissioner’s regulations, in general, require an allocation of the higher-earning nonpurpose “acquired obligations” to bond proceeds under an accounting pooling convention. These regulations, however, continue to reflect that the “acquired obligations” to be scrutinized are those acquired by the State or local government that issues the bonds. Thus, section 1.103-13(f)(1), Income Tax Regs., provides: In general. A State or local government unit shall allocate the cost of its acquired obligations to the unspent proceeds of each issue of governmental obligations issued by such unit. * * * [Emphasis added.] Congress added another important provision in the Tax Reform Act of 1986 when it provided that a bond will be considered an arbitrage bond if, after the bond is issued, the issuer intentionally uses the proceeds to earn arbitrage. Sec. 148(a), as added by TRA sec. 1301(b), 100 Stat. 2641; see H. Conf. Rept. 98-841, at II-746 (1986), 1986-3 C.B. (Vol. 4) 1, 746. By its terms, section 148(a) will remove the tax-exempt status of a bond retroactively, but only when the issuer intentionally contravenes the provisions against arbitrage. This new provision thus provides an exception to the assurances earlier provided by Assistant Secretary Lubick that the tax-exempt status of a bond would be determined as of the date of issue. The legislative history of the arbitrage and rebate provisions shows a consistent congressional intent that State and local governments (the issuers) not profit from arbitrage. It is plain that, in requiring rebates of excess earnings on “nonpurpose investments”, Congress contemplated investments made by the issuers, not unauthorized investments of bond proceeds diverted to improper uses by others. As petitioners state in their brief: “Nothing * * * suggests that money once stolen is subject to the yield restriction rules”. When Congress enacted section 148(f), it did not intend to require the rebate of arbitrage created by the unauthorized acts of persons other than the issuer and not received by the issuer. Such amounts are not amounts earned on nonpurpose investments within the meaning of that provision. My conclusion is reinforced by Congress’ contemporaneous inclusion of section 148(a) in the Tax Reform Act of 1986. As a result of the enactment of section 148(a), Congress expanded the definition of arbitrage bonds to include those that involved the issuer’s intentional acquisition of post-issuance arbitrage earnings. Congress thus put the tax exemption for interest earned on bonds at risk where a State or its subdivision intentionally used the bond proceeds to earn arbitrage profits. In such a circumstance, a violation of section 148(a) cannot be cured. However, by enacting section 148(f), Congress permitted the use of the rebate provisions to preserve the bonds’ exempt status in situations where the issuer unintentionally made a post-issuance, nonpurpose investment that yielded earnings in excess of the bond earnings. Section 148(f) by its terms applies only to amounts earned on nonpurpose investments. Nothing in section 148(f) indicates that it should apply to an issuer that did not make any nonpurpose investment.   Statutory text should not be read in an atmosphere of sterility, but rather in the context of the specific facts and circumstances of each case. See 2A Singer, Sutherland Statutory Construction, sec. 45.12, at 61 (5th ed. 1992). “The use of literalism suggests that a judge puts on blinders, so to speak, obscuring from view everything but the text of the statute whose effect on the matter at issue is in question.” Id. sec. 46.02, at 92.    Admittedly, the bonds were industrial development bonds under sec. 103(b)(2). However, the bonds come within the exception provided by sec. 103(b)(4)(A). That section provides that the interest on the obligations is not taxable as long as substantially all of the proceeds are to be used to construct residential rental property where 20 percent or more of the units in each project are to be occupied by individuals of low or moderate income. Such obligations are referred to in the body of this dissent as nontaxable industrial development bonds. Pursuant to sec. 1.103-8(b)(6)(iii), Income Tax Regs., the “substantially all” requirements of sec. 103(b)(4) do not apply to a project in the event of “involuntary noncompliance”, provided the obligation used to provide financing for the project is retired within a reasonable period. In my opinion, the bonds satisfied the “substantially all” requirements of sec. 1.103-8(b)(6)(iii), Income Tax Regs., because the Whitewater and Ironwood projects were not constructed due to “involuntary noncompliance” on the part of the Housing Authority of Riverside County. Further, because the bond proceeds were improperly locked into GIC’s, the term of the GIC’s determined when the bonds could be retired. Morever, with respect to the Whitewater bonds, I would hold that their issuance satisfied the reasonable public notice requirements of sec. 103(k)(2)(B)(i).    The majority opinion has adopted my findings of fact. See majority op. p. 262.    In basic bond financing, bond proceeds are disbursed directly to the developer in exchange for the developer’s note, which is secured by a lien on the underlying project (including the anticipated revenue stream). In many instances, a credit enhancement instrument, such as a letter of credit, is obtained. The bond issue in this case involved a form of “black box” structure. Theoretically, in such a structure, the bond proceeds are disbursed to the developer pursuant to an unsecured loan agreement with the issuer. The developer then invests the bond proceeds with a financial institution. Simultaneously, the developer procures a letter of credit to secure repayment of the bonds from another institution (the L/C provider) in exchange for a mortgage on the project. The L/C provider simultaneously sells the project mortgage to the financial institution where the bond proceeds are invested. Finally, and also simultaneously with the other transactions, the L/C provider purchases a GIC from an insurance carrier and hypothecates it to secure the interest and principal payments on the bonds. Thus, in theory, the black box structure makes bond proceeds available to a developer for construction on a credit enhanced and rated basis. In this case, the black box structure was corrupted by the use of Unified, a shell entity, instead of a bona fide financial institution that was supposed to be both the depository of the bond proceeds and the buyer (from separate funds) of the project mortgage from the L/C provider. Because Unified had no substantial capital of its own, it used the bond proceeds to buy the project mortgage; and via this route, the bond proceeds were invested in the GIC’s. Unified improperly used the bond proceeds to purchase the GIC’s, causing the Commissioner to assert that the bonds are to be treated as arbitrage bonds pursuant to the provisions of sec. 148(f). Hence, the central failure in this case was the improper use of the bond proceeds by Unified to purchase the GIC’s.    I agree with the majority’s conclusion that the date of issuance of the bonds was not Dec. 31, 1985, but rather Feb. 20, 1986.