- 20 -
rejection of respondent's yield argument does not, however, end
our inquiry.
Petitioner concedes that, if the discount is taken into
account, the yield is 7.57484 percent, which is more than
sufficient to constitute a materially higher yield than the 6
percent yield on the proposed bonds.8 Petitioner contends,
however, that the discount should not be taken into account and
that the proper yield for purposes of comparison is the 4.25-
percent interest rate on the City Obligation. We disagree. If
the discount is not taken into account, one is faced with a most
peculiar situation, namely, a borrowing at 6-percent interest to
pay off an obligation bearing 4.25-percent interest. It is only
because of the discount that the prepayment and the financing
thereof at a 6-percent interest rate make any sense. Indeed,
that is the clear foundation of the transactions and the
substantive justification for the prepayment.
In sum, we hold that, however one views the transactions
involved herein, a principal purpose of the City was to replace
the City Obligation with a payment for an investment in the State
A materially higher yield, with exceptions not applicable
herein, is a yield one-eighth of 1 percentage point greater than
that of the issue in question. Sec. 1.148-2(d)(2), Income Tax
Regs.; Staff of the Joint Comm. on Taxation, General Explanation
of the Tax Reform Act of 1986, at 1201-1202 (J. Comm. Print
1987).
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