Rev. Rul. 82-144

ISSUE

Will the purchaser of tax-exempt obligations, under the circumstances described below, be considered the owner of the obligations for federal income tax purposes when the obligations were acquired at the same time as a "put" with respect to those obligations?

FACTS

Taxpayer was organized as a Massachusetts business trust, and was classified as an association taxable as a corporation for federal income tax purposes. It was formed to invest in municipal obligations the interest on which is exempt from tax under section 103(a) of the Internal Revenue Code. Taxpayer satisfies the requirements of section 851(a) of the Code and expects to meet the additional requirements of section 851(b) and qualify each year as a "regulated investment company."

Under the terms of the trust agreement the beneficiaries (shareholders) of the taxpayer are free to invest or withdraw their funds at any time without sales charges or redemption fees. There are no minimum periods for investment and no penalties upon withdrawal. Because of these features the taxpayer, when it purchased its portfolio of short-term (1 year or less) municipal obligations from X, a dealer in securities, simultaneously purchased from X a small number of "put" agreements ("puts"). The purpose for the acquisition of the "puts" was to increase the liquidity of some of the obligations purchased in order to provide cash for the demands of those shareholders deciding to withdraw their investments.

The price paid to X for the "puts" was in addition to the price of the obligations, which were purchased at their fair market value. The "puts" provide that the taxpayer has the option or right to require X to repurchase the obligations. The terms of the "puts" establish the price that X must pay for the obligations should the taxpayer elect to exercise its rights under the agreements. All of the "puts" are for periods substantially less than the life of the obligations to which they apply, are nonassignable, and terminate if the obligations to which they relate are disposed of by the taxpayer.

There are no restrictions on the sale or disposition of the obligations by the taxpayer. In addition, there are no "call" agreements (an agreement giving X the option or right to reacquire the obligations at a fixed price for a specific period of time), either formal or informal, expressed or implied, existing between the taxpayer and X. X has no rights in the obligations acquired by the taxpayer and will not be soliciting buyers for the obligations for its account while the obligations are held by the taxpayer. The obligations were acquired by taxpayer for its own account and not as security on funds advanced to X.

LAW AND ANALYSIS

In Rev. Rul. 74-27, 1974-1 C.B. 24, the Service listed five factors that were relevant in determining whether a "purchase and resale agreement" was a sale between a bank and its customer of municipal bonds. Of the five factors listed in Rev. Rul. 74-27 that resulted in the Service characterizing the transaction as a loan rather than a sale, only three are relevant to the facts of this revenue ruling. Those three are: (1) the identical securities "sold" to the bank were required to be held for "repurchase" by the customer upon performance under the agreement to repurchase; (2) upon default by the customer the bank had the right to sell the securities and account for funds as in a debtor-creditor relationship; and (3) the customer was legally bound to repurchase the securities and to pay any deficiency remaining unpaid after the application of the proceeds of sale.

In Union Planters National Bank of Memphis v. United States, 426 F.2d 115 (6th Cir. 1970), cert. denied, 400 U.S. 827 (1970), the court addressed the issue of whether an agreement under which a bond dealer sold municipal obligations to a bank, subject to the bank's right to require the dealer to repurchase the municipal obligations at the price paid by the bank, was a sale for federal income tax purposes. In characterizing the transaction as a loan between the bank and the bond dealer, the court based its decision on the economic substance of the transaction rather than its form. The court noted that it was the intent and practice that the bonds be reacquired by the dealer upon the dealer's request and that the dealer was obligated to pay only the amount advanced by the bank to reacquire the municipal obligations and not their fair market value. Further, the court noted that in a transaction characterized as a sale for federal income tax purposes it would expect the bank (the purchaser) rather than the dealer (the seller) to assume the risk of fluctuations in the market value of the bonds. See also American National Bank of Austin v. United States, 421 F.2d 442 (5th Cir. 1970), cert. denied, 400 U.S. 819 (1970) and First American National Bank of Nashville v. United States, 467 F.2d 1098 (6th Cir. 1972).

Although no absolute rule can be established to determine which party to a transaction will be considered the owner of the property involved in all situations because of the factual nature of the issue, as a general rule the party to the transaction that bears the economic burdens and benefits of ownership will be considered the owner of the property for federal income tax purposes. In making the determination of which party bears the economic burdens and benefits of ownership, two significant factors of ownership are: (1) which party to the transaction has the right to dispose of the property; and (2) which party bears the risk of profit or loss with respect to the property. See Union Planters National Bank of Memphis.

Unlike the banks in Rev. Rul. 74-27 and Union Planters National Bank of Memphis, the taxpayer was not holding the obligations as security on a loan or for the benefit of X. Rather, the taxpayer was holding the obligations for its own benefit and was free to dispose of the obligations at any time. Further, instead of having to account to X for the proceeds realized on the sale of the obligations, as was the case with the bank in Rev. Rul. 74-27, the taxpayer was entitled to the full benefit of any appreciation in the value of the obligations.

Although the acquisition of the "puts", like the resale agreements in Rev. Rul. 74-27 and United Planters National Bank of Memphis, limits the risk of loss there are important differences between them. First, unlike the facts in Rev. Rul. 74-27 or Union Planters National Bank of Memphis, the taxpayer paid an arm's-length price for the "puts". The price paid for the "puts" represented the taxpayer's and X's estimation of the value of the risk that X was assuming under the "puts", independent of the taxpayer's acquisition of the obligations. Second, the primary purpose of the "puts" was to increase the liquidity of the taxpayer's portfolio of obligations rather than to shift the risk of loss. Third, unlike the facts in Rev. Rul. 74-27 and Union Planters National Bank of Memphis where the risk of loss was transferred for the entire period the securities were held, the shifting of risk under the facts described herein was for a definite period that was substantially less than the life of the obligations.

HOLDING

Under the circumstances described above, the purchaser of tax-exempt obligations will be considered the owner of the obligations for federal income tax purposes notwithstanding the fact that a "put" agreement was acquired simultaneously with the acquisition of the obligations.