Wastewater equalization and neutralization facility qualified as a sewage facility

Plain-English summary

The IRS considered whether a pharmaceutical company's wastewater equalization and neutralization facility qualified as a sewage facility for exempt facility bond purposes. The facility collected, equalized, and neutralized wastewater before sending it to a public treatment works that performed secondary treatment. The IRS concluded that the facility's functional relationship to the public treatment works made its collection, storage, and processing property necessary for secondary treatment, and that the remaining listed property was functionally related and subordinate. The memo therefore treated the facility as a sewage facility under § 142(a)(5), based on the described facts.

Ruling snapshot

• Question: Does the described wastewater equalization and neutralization facility qualify as a sewage facility under IRC § 142(a)(5)?
• Outcome: Advice given
• Key authorities: IRC §§ 103, 141, 142, 146, and 147; Treas. Reg. §§ 1.103-8(a)(3) and 1.142(a)(5)-1; 26 U.S.C. § 6110(k)(3).

Full text (IRS public release)

                           INTERNAL REVENUE SERVICE
                 NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                            March 15, 2010

                                                  Third Party Communication: None
                                                  Date of Communication: Not Applicable

Number: 201025048
Release Date: 6/25/2010
Index (UIL) No.: 142.10-00
CASE-MIS No.: TAM-141891-09

Director

     Taxpayer's Name:                             ---------------------------------------------------------------
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     Taxpayer's Address:                          ----------------------------------------------
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     Taxpayer's Identification No                 ----------------
     Year(s) Involved:
     Date of Conference:                          ---------------------------

LEGEND:

Issuer ------------------------------------------------------------------------------------------

State -------------------------------------------------

Company ------------------------------------------------------------------

Bonds ------------------------------------------------------------------------------------------
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Municipality -----------------------------------

Date 1 ----------------

Date 2 ------------------

TAM-141891-09 2

a ----

b -------

ISSUE:

Whether the Facility (as described below), or any portion thereof, constitutes a sewage
facility within the meaning of § 142(a)(5) of the Internal Revenue Code and
§ 1.142(a)(5)-1 of the Income Tax Regulations.

CONCLUSION:

The Facility is a sewage facility under § 142(a)(5) because it consists of (a) property
used for the collection, storage, and processing of wastewater, which property is
necessary for secondary treatment under § 1.142(a)(5)-1(b)(1)(iv)(A), and (b) property
that is functionally related and subordinate to such property under § 1.142(a)(5)-
1(b)(1)(vi).

FACTS:

Issuer is a public instrumentality and body corporate and politic of State. Issuer was
created pursuant to state law to provide financing for qualifying projects (including,
without limitation, industrial facilities, commercial facilities, pollution control facilities, and
public facilities) located in State.

On Date 1, Company and Issuer entered into an agreement (Agreement) whereby
Issuer would issue Bonds and loan the proceeds to Company to finance the
construction and acquisition of the Facility. On Date 2, Issuer issued Bonds to finance
the Facility as a sewage facility within the meaning of § 142(a)(5) and § 1.142(a)(5)-
1(b). Bonds are payable from and secured by loan payments to be made by Company
to Issuer under the Agreement.

Company is a pharmaceutical company that discovers, develops, manufactures, and
markets a range of products used to improve human and animal health. Company
owns and operates a research and manufacturing facility (Plant) in State. The Plant
generates wastewater that contains organic pollutants having a raw biochemical oxygen
demand of less than 350 milligrams per liter. This wastewater is discharged to
Municipality’s publicly owned treatment works (POTW) under a permit (Permit) issued
by the POTW to Company. The POTW performs secondary treatment of wastewater
from the Plant and from other sources. The POTW is located approximately a miles
away from the Plant.

Using Bond proceeds, Company financed the construction of a wastewater equalization
and neutralization facility (Facility) located adjacent to the Plant and owned and

TAM-141891-09 3

operated by Company. The Facility is comprised of equalization tanks, a concrete
containment dike, piping and associated platforms, a pH neutralization system, mixing
equipment, an air scrubber, an approximately b square foot building (Building), and
miscellaneous related site work (e.g., utilities and roadways). The Building houses two
laboratories, office space, a control room, a mechanical room, an emergency generator
room, restrooms, a garage, and a loading dock. The office space is directly related to the
day-to-day operations of the Facility.

The Facility performs two functions. First, it collects the Plant wastewater in the
equalization tanks and equalizes the pressure of the wastewater. This pressure
equalization reduces the impact of the Plant wastewater on the POTW by controlling
peak discharge flow rates. Second, the equalized wastewater is neutralized and
adjusted to a pH level that is acceptable to the POTW under the Permit. Such
neutralization is required for the proper operation of the POTW’s wastewater treatment
methods because the POTW treats wastewater by using biological methods to remove
solids and nutrients, breakdown organic matter, and destroy pathogens. Wastewater
with pH outside the acceptable range can be harmful to the bacteria that digest organic
material. Once the wastewater is collected, equalized, and neutralized, it is discharged
from the Facility to the POTW.

No “preliminary treatment,” “primary treatment,” “secondary treatment,” “advanced or
tertiary treatment”, or “pretreatment” of the wastewater is conducted at the Facility, and
no “septage” is processed at the Facility, as those terms are used in § 1.142(a)(5)-1.

LAW AND ANALYSIS:

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

Section 141(e) provides, in part, that the term “qualified bond” means any private
activity bond that is an exempt facility bond issued as part of an issue which meets the
applicable requirements of §§ 146 and 147.

Section 142(a)(5) provides, in pertinent part, that the term “exempt facility bond” means
any bond issued as part of an issue 95 percent or more of the net proceeds of which are
used to provide sewage facilities.

Section 142(b)(2) provides that an office shall not be treated as an exempt facility under
§ 142(a) unless the office is located on the premises of the facility, and not more than a
de minimis amount of the functions to be performed at such office is not directly related
to the day-to-day operations of the facility.

TAM-141891-09 4

Section 1.103-8(a)(3) provides that an exempt facility includes any land, building, or
other property functionally related and subordinate to such facility. Property is not
functionally related and subordinate to a facility if it is not of a character and size
commensurate with the character and size of such facility.

Section 1.142(a)(5)-1 defines the term “sewage facility” for purposes of § 142(a)(5).
Section 1.142(a)(5)-1(b)(1) provides that a sewage facility is property —

(i) Except as provided in § 1.142(a)(5)-1(b)(2) and (d), used for the secondary
treatment of wastewater; however, for property treating wastewater reasonably
expected to have an average daily raw wasteload concentration of biochemical
oxygen demand (BOD) that exceeds 350 milligrams per liter as oxygen
(measured at the time the influent enters the facility) (the BOD limit),
§ 1.142(a)(5)-1(b)(1)(i) applies only to the extent the treatment is for wastewater
having an average daily raw wasteload concentration of BOD that does not
exceed the BOD limit;

(ii) Used for the preliminary and/or primary treatment of wastewater but only to the
extent used in connection with secondary treatment (without regard to the BOD
limit described in § 1.142(a)(5)-1(b)(1)(i));

(iii) Used for the advanced or tertiary treatment of wastewater but only to the extent
used in connection with and after secondary treatment;

(iv) Used for the collection, storage, use, processing, or final disposal of —

      A. Wastewater, which property is necessary for such preliminary, primary,
         secondary, advanced, or tertiary treatment; or

      B. Sewage sludge removed during such preliminary, primary, secondary,
         advanced, or tertiary treatment (without regard to the BOD limit described
         in § 1.142(a)(5)-1(b)(1)(i));

(v) Used for the treatment, collection, storage, use, processing, or final disposal of
septage (without regard to the BOD limit described in § 1.142(a)(5)-1(b)(1)(i));
and

(vi) Functionally related and subordinate to property described in § 1.142(a)(5)-
1(b)(1), such as sewage disinfection property.

Section 1.142(a)(5)-1(b)(3) provides definitions of certain terms used in
§ 1.142(a)(5)-1:

  (i) Advanced or tertiary treatment means the treatment of wastewater after

secondary treatment. Advanced or tertiary treatment ranges from biological treatment

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extensions to physical-chemical separation techniques such as denitrification, ammonia
stripping, carbon adsorption, and chemical precipitation.

  (ii) Nonconventional pollutants are any pollutants that are not listed in 40 C.F.R.

401.15, 401.16, or appendix A to part 423.

   (iii) Preliminary treatment means treatment that removes large extraneous

matter from incoming wastewater and renders the incoming wastewater more amenable
to subsequent treatment and handling.

   (iv) Pretreatment means a process that preconditions wastewater to neutralize

or remove toxic, priority, or nonconventional pollutants that could adversely affect
sewers or inhibit a preliminary, primary, secondary, advanced, or tertiary treatment
operation.

    (v) Primary treatment means treatment that removes material that floats or will

settle, usually by screens or settling tanks.

   (vi) Priority pollutants are those pollutants listed in appendix A to 40 CFR part

423.

   (vii) Secondary treatment means the stage in sewage treatment in which a

bacterial process (or an equivalent process) consumes the organic parts of wastes,
usually by trickling filters or an activated sludge process.

   (viii) Sewage sludge is defined in 40 CFR 122.2 and includes septage.

   (ix) Toxic pollutants are those pollutants listed in 40 CFR 401.15.

40 C.F.R. 401.16 provides a list of conventional pollutants, which includes: (1)
Biochemical oxygen demand (BOD), (2) Total suspended solids (nonfilterable) (TSS),
(3) pH, (4) Fecal coliform, and (5) Oil and grease.

Section 1.142(a)(5)-1(c) provides that property other than property described in
§ 1.142(a)(5)-1(b)(1) is not a sewage facility. Thus, for example, property is not a
sewage facility, or functionally related and subordinate property, if the property is used
for pretreatment of wastewater (whether or not this treatment is necessary to perform
preliminary, primary, secondary, advanced, or tertiary treatment), or the related
collection, storage, use, processing, or final disposal of the wastewater.

The request for technical advice questions whether the functional relationship between
the Facility property used to collect, store, equalize, and neutralize the Plant’s
wastewater and the secondary treatment of the wastewater performed by the POTW is
sufficient for such property to be considered “necessary,” as that term is used in

TAM-141891-09 6

§ 1.142(a)(5)-1(b)(1)(iv)(A), or whether some additional relationship (e.g., common
ownership or geographic proximity) must exist between the Facility and the POTW.

We conclude that the functional relationship between the property used to collect, store,
equalize, and neutralize the Plant’s wastewater, i.e., the Facility, and the secondary
treatment performed by the POTW is sufficient for such property to be considered
“necessary” under § 1.142(a)(5)-1(b)(1)(iv)(A). The secondary treatment of the Plant
wastewater at the POTW involves biological methods in which bacteria remove solids
and nutrients, breakdown organic matter, and destroy pathogens. The viability of this
bacteria are necessary conditions for the proper operation of POTW’s wastewater
treatment methods. Anything introduced into the POTW that threatens the viability of
this bacteria threatens the ability of the POTW to perform the secondary treatment of
the Plant wastewater. The Facility neutralizes the Plant wastewater’s pH level before
the wastewater is discharged to the POTW because, without such neutralization, the pH
of the wastewater can result in harm to the bacteria utilized by the POTW in the
secondary treatment of the wastewater. In addition, the Facility controls the peak
discharge flow rates to the POTW by equalizing the pressure of the Plant’s wastewater.
This pressure equalization reduces and controls the impact of the wastewater on the
POTW by controlling the peak discharge flow rate from the Plant to the POTW.

The remainder of the Facility, including the air scrubber, the two laboratories, the office
space, the restrooms, and the garage and loading dock constitute property functionally
related and subordinate to property described in § 1.142(a)(5)-1(b)(1)(iv).

Nothing in § 142 or § 1.142(a)(5)-1 requires the existence of one or more specific
relationships, such as common ownership or geographic proximity, between the Facility
and the POTW in addition to the relationship described above when determining
whether the Facility is a sewage facility under § 1.142(a)(5)-(1)(b)(1)(iv)(A).
Accordingly, we conclude that the Facility is a sewage facility under § 142(a)(5)
because it consists of (a) property used for the collection, storage, and processing of
wastewater, which is necessary for the secondary treatment of the wastewater under

§ 1.142(a)(5)-1(B)(1)(iv)(A), and (b) property functionally related and subordinate to
such property under § 1.142(a)(5)-1(b)(1)(vi) of the regulations.

CAVEAT(S):

A copy of this technical advice memorandum is to be given to the taxpayer(s). Section
6110(k)(3) of the Code provides that it may not be used or cited as precedent.