Government utility's shared generating facility avoids private business use

Plain-English summary

A city planned to issue bonds so its utility authority could buy an undivided interest in a new electric generating facility from a private company. The authority and company would form a tax partnership, own facility capacity in proportion to their capital contributions, share output in that same ratio, and allocate partnership tax items according to their ownership interests. Tax regulations treat properly proportioned undivided interests in an output facility as separate facilities and attribute partnership use according to the partners' shares. Because the private company's use would not be attributed to the authority's bond-financed interest, the IRS ruled that the acquisition would not create private business use of the bonds. The IRS did not rule on later changes, partnership termination, or whether bond interest was otherwise tax-exempt under IRC § 103.

Ruling snapshot

• Question: Would the private company's participation in a jointly owned generating facility create private business use of the authority's bond-financed interest?
• Outcome: Approved, no private business use resulted under the described ownership and allocation terms
• Key authorities: IRC §§ 103, 141, and 704(b); Treas. Reg. §§ 1.141-1 through 1.141-6

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201630011 Third Party Communication: None
Release Date: 7/22/2016 Date of Communication: Not Applicable
Index Number: 141.00-00
Person To Contact:
---------------------------------------- ----------------------, ID No. -----------------
------------------------------------------ Telephone Number:
----------------------------------- --------------------
------------------------------------------ Refer Reply To:
CC:FIP:BRANCH 5
PLR-135298-15
Date:
April 20, 2016

Legend

City = ----------------------------------------------------------------

Authority = ------------------------------------------------------------------------------------------
----------------------

Bonds = ------------------------------------------------------------------------------------------
--------------------------------------------

Company = ----------------------------------------------------------------------

State = -------------------------

Date 1 = -----------------------

a = -----

Dear ------------ :

This is in response to the request for a ruling submitted by City that the use of the
proceeds of the Bonds by Authority, an instrumentality of City, to acquire an undivided
ownership interest in an electric generating facility and related assets and property
(Facility) under the circumstances described below will not result in private business use
of the Bonds (as defined in § 141(b)(6) for purposes of § 141(b)(1) of the Internal
Revenue Code (Code)).

PLR-135298-15 2

City’s combined electric, water and wastewater system is managed, operated, and
maintained by Authority. Company is a limited liability company that is a partnership for
federal income tax purposes.

On Date 1, Authority and Company entered into an agreement (Agreement) for the sale
to Authority of an undivided ownership interest (Authority Ownership Interest) in the
Facility to be constructed by Company in State. City will issue the Bonds to enable the
Authority to finance the purchase of the Authority Ownership Interest, which will serve
as a base-load plant for the Authority. Company will own the remaining interest in the
Facility as an undivided ownership interest (Company Ownership Interest) (collectively
with Authority Ownership Interest, referred to as Ownership Interests). The Agreement
will create a tax partnership between Authority and Company (Partnership) with the
Facility comprising the partnership assets.

The respective Ownership Interests will be established based on the Facility’s total
power generating capacity (as defined in the Agreement), which is to be determined as
of the completion date of the Facility. The amount of Authority Ownership Interest will
be equal to a megawatts of capacity out of the total capacity of the Facility, expressed
as a percentage. The amount of Company Ownership Interest of the Facility will be the
remaining percentage of the capacity.

The agreed upon purchase price for the Authority Ownership Interest (Purchase Price)
was determined after, and as a result of, arm’s length negotiations between Authority
and Company. The fair market value of the Facility will be allocated to Authority’s and
Company’s respective fair market value capital accounts, kept pursuant to § 704(b) of
the Code, in proportion to the fair market value of their respective Ownership Interests.
The fair market value capital accounts of Authority and Company will be maintained in
proportion to the ratio of their respective ownership interests (Ownership Ratio) during
the entire term of the Partnership. The Agreement provides that the allocation of tax
partnership items of income, gain, loss, or deduction will be made in accordance with
the Ownership Ratio.

LAW AND ANALYSIS

Section 103(a) of the Code provides that gross income does not include interest on any
state or local bond. Section 103(b)(1) provides that § 103(a) does not apply to any
private activity bond which is not a qualified bond within the meaning of § 141.

Section 141(a) provides that a private activity bond is any bond issued as part of an
issue that meets either (1) the private business use test of § 141(b)(1) and the private
security or payment test of § 141(b)(2), or (2) the private loan financing test of § 141(c).

Section 141(b)(1) provides that, generally, a bond issue meets the private business use
test if more than 10 percent of the proceeds of the issue are to be used for any private

PLR-135298-15 3

business use. Section 141(b)(6)(A) provides that the term "private business use"
means use (directly or indirectly) in a trade or business carried on by any person other
than a governmental unit.

Section 1.141-1(b) of the Income Tax Regulations defines a nongovernmental person
as a person other than a governmental person. A governmental person means a state
or local governmental unit as defined in § 1.103-1 or any instrumentality thereof.
Section 1.141-1(b) defines an output facility as an electric and gas generation,
transmission, distribution, and related facilities, and water collection, storage, and
distribution facilities. Section 1.141–1(e) provides that a partnership (as defined in
section 7701(a)(2)) is treated as an aggregate of its partners, rather than as an entity.

Section 1.141-2(a) provides, in part, that the private activity bond tests serve to identify
arrangements that have the potential to transfer the benefits of tax-exempt financing, as
well as arrangements that actually transfer these benefits. The regulations under § 141
may not be applied in a manner that is inconsistent with these purposes.

Under § 1.141-3(b)(1) both actual and beneficial use by a nongovernmental person may
be treated as private business use. In general, a nongovernmental person is treated as
a private business user of proceeds and financed property as a result of ownership;
actual or beneficial use of property pursuant to a lease, or a management or incentive
payment contract; or certain other arrangements such as a take or pay or other output-
type contract.

Section 1.141-3(g)(2)(i) provides that, in general, the measurement period of property
financed by an issue begins on the later of the issue date of that issue or the date the
property is placed in service and ends on the earlier of the last date of the reasonably
expected economic life of the property or the latest maturity date of any bond of the
issue financing the property (determined without regard to any optional redemption
dates).

Section 1.141-3(g)(2)(iv) provides that the amount of private business use resulting from
ownership by a nongovernmental person is the greatest percentage of private business
use in any 1-year period during the measurement period; however, § 1.141-3(g)(2)(v)(A)
sets forth a special rule for partners that are nongovernmental persons. Under this rule,
the amount of private business use by a nongovernmental partner is the partner’s share
of the amount of use of the property by the partnership. Except as otherwise provided
in § 1.141-3(g)(2)(v)(B), a nongovernmental partner’s share of the partnership’s use of
the property is the nongovernmental partner’s greatest percentage share under § 704(b)
of any partnership item of income, gain, loss, deduction, or credit attributable to the
period that the partnership uses the property during the measurement period.

Under § 1.141-3(g)(1), the private business use of proceeds is allocated to property
under § 1.141-6. Section 1.141-6(a)(3)(ii) provides that if an output facility has multiple

PLR-135298-15 4

undivided ownership interests (respectively owned by governmental and
nongovernmental persons), each owner’s interest in the facility is treated as a separate
facility for purposes of § 1.141-6, if all owners of the undivided ownership interests
share the ownership and output in proportion to their contributions to the capital costs of
the output facility.

In this case, for purposes of § 1.141-6, the Facility is an output facility under § 1.141-
1(b). As an output facility, the Authority Ownership Interest may be treated as a
separate facility for purposes of § 1.141-6. Authority purchased Authority Ownership
Interest in an arm’s length transaction, and Authority and Company will share the output
of the Facility in proportion to their respective Ownership Interests.

Further, we must determine whether use of the Facility by the Partnership will result in
use of the Authority Ownership Interest that is attributable to Company as a partner. In
this case, during the term of the Partnership, Authority and Company will allocate
partnership items of income, gain, loss and deductions under § 704(b) according to the
Ownership Ratio. Thus, no private business use of the Bond-financed Authority
Ownership Interest by Partnership will be attributable to Company.

CONCLUSION

Based on the foregoing, we conclude that the use of the proceeds of the Bonds to
acquire the Authority Ownership Interest under the Agreement will not result in private
business use of the Bonds.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter, including the effects of the termination of the Partnership or a change in the
allocation of tax partnership items of income, gain, loss, or deduction under section
704(b) of the Code during the measurement period on the tax-exempt status of the
Bonds, or whether the interest on the Bonds is excludable under § 103 of the Code.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

The rulings contained in this letter are based upon information and representations

PLR-135298-15 5

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                 Sincerely,

                                     /S/

                                 Timothy L. Jones
                                 Senior Counsel
                                 (Financial Institutions & Products)