Rev. Rul. 54-296

Advice is requested regarding the treatment, for Federal income tax purposes of (1) a nonprofit corporation to be formed under the general corporation laws of the State for the purpose of converting certain municipally owned property to community use and (2) interest on the debenture notes to be issued by the corporation for the purpose of financing such improvements.

A group of public spirited citizens feel that the city of M has pressing need of a structure suitable for general purposes, civic and recreational use such as sporting events, various school functions and other municipal enterprises. Efforts have been made to get the city to convert certain of its municipally owned property into such a structure. However, due to many other demands for expenditures by the city for capital improvements of a very pressing nature, the city council has been reluctant to appropriate funds to effect such conversion.

It is proposed that a nonprofit corporation be formed to effect the desired improvements to the municipally owned property and that all of the capital stock of the corporation be issued to the city of M in exchange for a lease on the property, the lease to provide that at the end of its term or as soon as the indebtedness of the corporation is retired by it, or when the city assumes or discharges the outstanding debt of the corporation, whichever occurs first, the city would then become absolute owner of the improvements.

Under the plan the funds necessary to make the improvements would be borrowed on debenture notes issued by the corporation, secured by a pledge of the net revenues from the rentals of the improved property, and the debt would be liquidated from the proceeds of operations over a period approximately the length of the lease. None of the revenue will ever accrue to the benefit of any person, firm, or corporation, except the city of M, whose only direct benefit would be the value of the improvements.

On the basis of the facts present in this case, it is held that the income to be earned from the rentals of a municipally owned building by a nonprofit corporation to be formed under the general corporation laws of the State by a group of public spirited citizens to effect desired improvements to such building, and which income will never accrue to the benefit of any person, firm, or corporation except the municipality, will not be subject to Federal income tax.

Section 22(b)(4) of the Internal Revenue Code provides, in part, as follows:

(b) EXCLUSIONS FROM GROSS INCOME.-The following items shall not be included in gross income and shall be exempt from taxation under this chapter:

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(4) TAX-FREE INTEREST.-Interest upon (a) the obligations of a State, Territory, or any political subdivision, thereof, * * *.

Accordingly, proposed debenture notes to be issued by the corporation for the purpose of financing the desired improvements will be considered as issued in behalf of the municipality which is the sole stockholder of the corporation, and the interest paid thereon will be exempt from Federal income tax under section 22(b)(4) of the Internal Revenue Code. Cf. Rev. Rul. 54-106, C.B. 1954-1, 28.