TRUSTEE'S POWER TO CHANGE CREDIT SUPPORT OF INVESTMENT TRUST'S DEBT OBLIGATIONS IS NOT 'POWER TO VARY THE INVESTMENT.'

Rev. Rul. 90-63

ISSUE

If the trustee of an investment trust has a power to consent to changes in the credit support of debt obligations that is exercisable only to the extent the trustee reasonably believes the change is advisable to maintain the value of trust property by preserving the credit rating of the obligations, is such power a "power to vary the investment" within the meaning of section 301.7701-4(c) of the Procedure and Administration Regulations?

FACTS

S, a financial services corporation, created an investment trust funded with a fixed portfolio that included a certain issue of tax- exempt debt obligations.

The tax-exempt debt obligations are exempt facility bonds issued by C, a municipal corporation, to provide a solid waste disposal facility described in section 142(a)(6) of the Internal Revenue Code. The bonds are payable only from the revenues derived from the facility and are nonrecourse as to C.

C and D, a corporation, entered into a loan agreement pursuant to which C loaned the proceeds from the issuance of the bonds to D for the development of the facility. Under the terms of the loan agreement, D is required to provide credit support in the form of a letter of credit from a financial institution specified in the agreement.

Under the terms of the trust agreement, the trustee, at C's request, may consent to a change in the credit support if the trustee reasonably believes that the change is advisable to maintain the value of trust assets by preserving the credit rating of the bonds.

LAW AND ANALYSIS

Section 301.7701-4(c) of the regulations provides that an investment trust with a single class of ownership interests, representing undivided beneficial interests in the assets of the trust, is properly classified as a trust if there is no power under the trust agreement to vary the investment of the beneficiaries.

A power to vary the investment of the certificate holders is one that enables the trustee or another person to take advantage of market variations to improve the investment of all the beneficiaries. The existence of such a power is sufficient to turn the venture into a business, thereby precluding classification of the entity as a trust for federal tax purposes. See Commissioner v. North American Bond Trust, 122 F.2d 545 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942).

In the present case, the power to consent to changes in the credit support provided under the loan agreement does not permit the trustee to alter any of the other terms of the bond issue held by the trust. Furthermore, the trustee is permitted to accept changes in the credit support only when the trustee reasonably believes the change is advisable to maintain the value of trust property by preserving the credit rating of the bonds. Although it is possible that a proposed change would result in an increase in the value of the bonds held by the trust, any such increase would be incidental to maintaining the value of trust property. Thus, the increase would not be the result of trading in securities and thereby profiting from market fluctuations. Accordingly, the power is not a power to vary the investment as that term is used in section 301.7701-4(c) of the regulations.

HOLDING

The power to consent to changes in the credit support for debt obligations held in an investment trust is not a "power to vary the investment" within the meaning of section 301.7701-4(c) of the Procedure and Administration Regulations if it is exercisable only to the extent the trustee reasonably believes the change is advisable to maintain the value of trust property by preserving the credit rating of the bonds.

DRAFTING INFORMATION

The principal author of this revenue ruling is Margaret O'Connor of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Ms. O'Connor on (202) 566-4751 (not a toll-free call).