Governmental commodity authority's income excluded under section 115

Plain-English summary

A nonprofit authority was formed by governmental members to buy, sell, manage, and distribute a redacted commodity on their behalf. Its members were political subdivisions or entities whose income was already excluded under section 115, and only such governmental entities could become members. The authority pooled activities that the members had historically performed themselves, including commodity purchases, sales, hedges, and regulated balancing transactions with third parties. Its net revenues flowed back to members, its assets would go to members on dissolution, and no director, officer, trustee, or private person could receive its income. The IRS concluded that these activities performed an essential governmental function and that any benefit to third-party transaction partners was incidental. It therefore ruled that the authority's income was excluded from gross income under section 115(1).

Ruling snapshot

• Question: Is the authority's income excluded because it performs an essential governmental function and its income accrues to governmental members?
• Outcome: approved (the authority's income is excluded from gross income under section 115(1))
• Key authorities: IRC § 115(1); Rev. Rul. 77-261; Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202019026 [Third Party Communication:
Release Date: 5/8/2020 Date of Communication: Month DD, YYYY]
Index Number: 115.03-00, 115.06-02
Person To Contact:
---------------------- ----------------------, ID No. -----------------
------------------------------------------- Telephone Number:
---------------------------- --------------------
-------------- Refer Reply To:
----------------------------------- CC:EEE:EOET:EO2
PLR-120195-19
Date:
February 07, 2020

Legend

Authority = --------------------------------------
Commodity(ies) = ---------------------------------
Commission = -----------------------------------------------------
Members = --------------------------------------------------------------------------------------
-----------
State = -----------
Third Parties = --------------------------------------------------------------------------------------
-------------------------------

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

This letter responds to a ruling letter request from your authorized representatives dated
August 29, 2019, and subsequent correspondence requesting a ruling that Authority’s
income will be excluded from gross income under § 115 of the Internal Revenue Code
(hereafter “Code”).

Facts and Representations

In requesting the present ruling, Authority represents the following. Authority is a
nonprofit corporation organized under the not-for-profit corporation law of State.
Authority was created to coordinate the operation, purchase, and sale of Commodities
on behalf of its Members. Authority currently has two members: Members. The
Members of Authority each own and operate facilities for the purpose of providing
Commodities to consumers in their service areas. The Members buy and sell
Commodities on the Commodity market. Authority represents that all current Members
are political subdivisions of their respective states or entities the income of which is
excluded from gross income under § 115 of the Code. All Members must be either
political subdivisions or entities the income of which is excluded from gross income
under § 115 of the Code.

PLR-120195-19 2

Authority is governed by a board of directors that are elected by a majority vote of all
Members. Members are required to make capital contributions to Authority and
revenues and expenses flow through to Members based upon membership interest.
Upon dissolution of Authority, its assets are distributed to its Members. The net
revenues of Authority are distributed monthly to its Members less a reasonable retention
for Authority’s working capital needs. No income of Authority shall inure to the benefit of
any director, officer, trustee, or private person.

Authority’s purpose is to purchase Commodities on the Commodity market and resell
those Commodities to its Members at a substantial savings. In addition to Commodity
sales, Authority will provide Commodity management and distribution services to its
Members.

Authority represents that it receives income resulting from: (1) the sales of Commodities
to its Members; (2) income generated from the investment of cash from Authority’s
purchases and sales of Commodities; and (3) Authority’s acquisition and termination of
commodity swaps and other hedges related to its purchases and sales of Commodities.

In order to insure that an adequate supply of Commodities are available for Authority’s
Members in case of an unexpected event, and to promote cost effective participation by
its Members in the wholesale Commodity market, Authority buys Commodities on the
Commodity market for sale to one or more Members (or Third Parties in the balancing
transactions described below). Authority also performs other services for its Members
related to managing their Commodity resources. In conducting these activities,
Authority performs for its Members on a consolidated basis, activities that the Members
have historically performed for themselves or that would have been entered into by
Authority’s Members if Authority did not exist.

Authority from time-to-time generates revenues from sales to non-members. Savings or
positive net margins, if any, from non-member sales are used to lower the costs of the
member whose assets or contracts are involved. These sales could be accomplished
by the member directly instead of through Authority. Non-member sales are generally
expected to include (i) sales of Commodities; (ii) sales of Commodities with respect to
supply contracts; and (iii) miscellaneous transactions, such as swap/trades, and
“balancing” transactions regulated by the Commission. With respect to these sales to
non-members, Authority represents that any benefit to nonmembers involved in the
sales transactions is no different from the benefit that would be provided if the member
itself performed the sale.

Authority represents that the Commission regulates both the transportation and
transmission of Commodities. The Commission requires that transporters and market
participants of Commodities be in balance—that the amount of Commodities purchased
equals the amount Commodities sold. To that end, Authority’s Members may use
diverse methods to balance transactions of Commodities. These balancing transactions

PLR-120195-19 3

will entail selling excess or purchasing more Commodities in an arm’s length transaction
to Third Parties. Authority represents that, in furtherance of maintaining its balance of
Commodity purchases and sales, it expects to enter into certain transactions with Third
Parties, such as buying Commodities on the Commodity market and selling
Commodities to Third Parties at market rates. Sales of Commodities to Third Parties
will be limited to transactions to maintain the balance of its purchases and sales of
Commodity as described above and as represented to by the Authority.

Authority itself may also engage in certain transactions to hedge their Members
Commodity supplies, such as entering into long-term commodity swaps to lock in the
Commodity’s price, and entering into commodity swaps that synthetically convert the
price of the Commodity to an indexed or variable price.

Ruling Requested

Authority requests a ruling that Authority’s income is excludible from gross income
under § 115 of the Code because the income of Authority derives from the exercise of
an essential governmental function and will accrue to a state or a political subdivision
thereof.

Law and Analysis

Section 115(1) of the Code provides that gross income does not include income derived
from any public utility or the exercise of any essential government function and accruing
to a state or any political subdivision thereof.

Rev. Rul. 77-261, 1977-2 C.B. 45, holds that income generated by an investment fund
that is established by a state to hold revenues in excess of the amounts needed to meet
current expenses is excludable from gross income under § 115(1) of the Code, because
such investment constitutes an essential governmental function. The ruling explains that
the statutory exclusion is intended to extend not to the income of a state or municipality
resulting from its own participation in activities, but rather to the income of an entity
engaged in the operation of a public utility or the performance of some governmental
function that accrues to either a state or political subdivision of a State. The ruling points
out that it may be assumed that Congress did not desire in any way to restrict a state’s
participation in enterprises that might be useful in carrying out projects that are
desirable from the standpoint of a State government and that are within the ambit of a
sovereign to conduct.

Rev. Rul. 90-74, 1990-2 C.B. 34, holds that the income of an organization formed,
funded, and operated by political subdivisions to pool various risks (e.g., casualty, public
liability, workers’ compensation, and employees’ health) is excludable from gross
income under § 115(1) of the Code because the organization is performing an essential
governmental function. The revenue ruling states that the income of such an

PLR-120195-19 4

organization is excluded from gross income so long as private interests do not
participate in the organization or benefit more than incidentally from the organization.

Authority is performing of an essential governmental function within the meaning of
section 115 of the Code. See Rev. Rul. 90-74 and Rev. Rul. 77-261.

No private interests will participate in, or benefit from, the operation of Authority other
than as providers of goods or services. The benefit to Third Parties is incidental to the
public benefit. See Rev. Rul. 90-74.

Ruling

Based solely on the facts and representations submitted by Authority, we conclude that:

    The income of Authority is derived from the exercise of an essential
    governmental function and will accrue to a state or a political subdivision thereof,
    or to an entity the income of which is excluded under § 115(1). Consequently,
    we rule that Authority’s income will be excluded from gross income under
    § 115(1).

The ruling contained in this letter is based upon information and representations
submitted by or on behalf of Authority and accompanied by a penalty of perjury
statement executed by an individual with authority to bind Authority, and upon the
understanding that there will be no material changes in the facts. While this office has
not verified any of the material submitted in support of the request for a ruling, it is
subject to verification on examination. The Associate office will revoke or modify a letter
ruling and apply the revocation retroactively if there has been a misstatement or
omission of controlling facts; the facts at the time of the transaction are materially
different from the controlling facts on which the ruling was based; or, in the case of a
transaction involving a continuing action or series of actions, the controlling facts
change during the course of the transaction. See Rev. Proc. 2020-1, § 11.05.

This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted other than with respect to the sections specifically described.
Further, except as expressly provided in this letter, no opinion is expressed or implied
concerning the tax consequences of any aspects of any transaction or item of income
discussed or referenced in this letter.

Because it could help resolve questions concerning federal income tax status, this letter
should be kept in Authority’s permanent records.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to Authority’s authorized representative.

PLR-120195-19 5

This ruling letter is directed only to Authority. According to § 6110(k)(3) of the Code,
this ruling letter may not be used or cited as precedent.

A copy of this letter must be attached to any tax return to which it is relevant.
Alternatively, if Authority files a return electronically, this requirement may be satisfied
by attaching a statement to the return that provides the date and control number of this
ruling letter.

                               Sincerely,

                               James Zelasko
                               Branch Chief
                               Office of Chief Counsel
                               (Employee Benefits, Exempt Organizations, and
                               Employment Taxes)

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