The Internal Revenue Service (the “Service”) released a Private Letter Ruling (“PLR”) earlier this year addressing private business use of a mixed-use output facility and whether tax-exempt bonds could be used to finance improvements to the facility. The Issuer, which is a political subdivision of a state, owns electric generation, transmission and distribution facilities that are managed by a non-governmental electric cooperative (“NGEC”) pursuant to several contractual arrangements. Under a power sales contract, the Issuer has the right to schedule or take the portion of power generated by the facility equal to the percentage of the facility’s net rated capacity reserved by Issuer for that year. If the Issuer does not schedule or take all the output from its reserved portion of the facility’s net rated capacity, it must offer the unused output to the NGEC before offering to third parties. The governing body of the Issuer establishes and approves the rates for power produced from Issuer’s reserved net rated capacity of the facility and sold to the Issuer’s customers. Under an operating agreement with the NGEC, the Issuer reimburses the NGEC for its share of the actual and direct expenditures incurred by the NGEC in the operation and maintenance of the facility. The Issuer’s share of expenses is determined by its reserved percentage of the facility’s net rated capacity.
The Issuer expects to finance capital improvements to the facility, the costs for which will be allocated between the Issuer and the NGEC on the basis of their respective reservations and allocations of the net rated capacity of the facility. The Issuer intends to issue tax-exempt governmental bonds to finance its portion of the improvement costs. The Issuer represents that, while the bonds are outstanding, it will (a) maintain its reserved net rated capacity and (b) take a sufficient amount of the total energy generated at the facility so that no more than 10% of the facility’s improvements that are to be financed with the bonds will used for private business use.
The Service first considered whether the facility constitutes public utility property under Section 168(i)(10) of the Code. “Public utility property” means property used predominantly in the trade or business of the furnishing or sale of electrical energy (among other things) if the rates for such furnishing or sale have been established or approved by a state or political subdivision thereof. Because the facility consists of property used predominantly in the trade or business of furnishing or sale of electricity and the Issuer establishes and approves rates for electricity provided by the Issuer from its reserved share of the net rated capacity of the facility, then, to the extent of such share, the facility constitutes public utility property.
Under the Advance Notice of Proposed Rulemaking, 2002-2 C.B. 685 (the “Advance Notice”), tax-exempt bonds may be issued to finance costs attributable to the government use portion of a mixed-use output facility, plus any costs attributable to permitted de minimis private business use. The government use portion is determined based on the percentage of the available output of the facility that is not used for a private business use. The available output is determined by multiplying the number of units produced or to be produced by the facility in one year by the number of years in the measurement period of that facility for that bond issue. The number of units produced or to be produced in one year is determined by reference to nameplate capacity or its equivalent, which is not reduced for reserves, maintenance or other unutilized capacity. See Treas. Reg. Sec. 1.141-6 and 7.
The Service noted that the allocation of output based upon reserved net rated capacity under the power sales contract is the equivalent of an allocation based on available output of the facility. Thus, the government use portion of the facility consists of the Issuer’s portion of the net rated capacity of the facility less the NGEC’s purchases of non-scheduled or taken output and any other private business use. Therefore, the Issuer may issue bonds in an amount to cover the costs of the government use portion of the facility and its improvements plus any costs attributed to permitted de minimis private business use.
Additionally, since only actual and direct expenses incurred in the operation and maintenance of the Issuer’s share of the facility are payable to the NGEC for its management of such share under the operating agreement, the operating agreement is not treated as a management contract that results in private business use by the NGEC. See Treas. Reg. Sec. 1.141-3.