PLR 1114010: IRS recognizes a public authority as a political subdivision and not a related party

Plain-English summary

The IRS ruled that a public authority formed by governmental entities qualified as a political subdivision for purposes of the tax rules on interest from state or local bonds. The authority was controlled by a governmental department and received powers including eminent domain, taxing, and regulatory powers. The IRS also ruled that the authority was not a related party to the city or district involved because those entities did not control its governing body or its funds. These conclusions allowed the authority to be treated according to the requested bond and related-party rules, based on the facts and representations submitted.

Ruling snapshot

• Question: Did the authority qualify as a political subdivision and avoid related-party status with the city and district?
• Outcome: Approved, both requested rulings granted.
• Key authorities: IRC §§ 103, 150, and 6110; Treas. Reg. §§ 1.103-1 and 1.150-1.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201114010 Third Party Communication: None
Release Date: 4/8/2011 Date of Communication: Not Applicable
Index Number: 103.00-00, 103.02-00,
103.02-01, 150.00-00, Person To Contact:
150.01-00 --------------------
Telephone Number:
----------------------- ---------------------
----------------------------------------------------------- Refer Reply To:
------------------------------ CC:FIP:BR5
------------------------------------ PLR-132892-10
----------------------------------------------- Date:
December 10, 2010

LEGEND:

Department = --------------------------------------------------------------

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Trustees = ---------------------------------------------------------------

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

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

District = ---------------------------------------------------------------

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

County = -------------------------------

System = ---------------------------------------------------------------

PLR-132892-10 2

a = ----

b = -----------

c = --

d = --

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

This responds to Department’s request for rulings that (1) Authority qualifies as a
political subdivision for purposes of § 103 of the Internal Revenue Code (the “Code”),
and (2) Authority is not a “related party” to either City or District under § 1.150-1(b) of
the Income Tax Regulations.

Facts and Representations

You make the following factual representations. Department, a political subdivision,
was created over a years ago by the State legislature pursuant to State statute as an
independent department of City free from political influence from the Mayor of City or
the City-County Council. Department is a broad-based utility that serves more than b
customers and manages a growing utility services business. Exclusive management
and control of Department is vested in its c-member board of directors (the “Department
Board”).

Members of the Department Board must be residents of City and are appointed
annually by the Trustees, a d-member board of trustees with no oversight by City. The
initial Trustees were appointed by the City Mayor, the City-County Council, and the
County Circuit Court judge with varying initial terms. Thereafter, the Trustees have
served staggered terms of four years. Upon expiration of a Trustee’s term (or if a
Trustee dies, resigns, becomes a nonresident of City or is otherwise removed), the
remaining Trustees nominate a successor, who is appointed by the City Mayor within 10
days. A Trustee may be removed from office only for cause, and only by an order and
judgment following the filing of a complaint by City in the local circuit or superior courts.
The Trustees may remove summarily and at any time any member of the Department
Board. City has no power to remove a member of the Department Board.

Department Board is granted the power to adopt rules for service and rates for service
in connection with the furnishing of service to its customers, subject to State approval.
Department Board has exclusive authority over expenditure of its funds. While
Department Board is required to make certain accounting and other reports to the City
controller, the books, accounts, records and transactions of Department and of
PLR-132892-10 3

Department Board are only subject to examination, audit, and supervision by the State
Board of Accounts to the same extent as other municipal governments or departments
of municipal governments.

Department is granted the power of eminent domain by State statute. Department may
act to condemn and hold any real estate within the City or within five miles of the
corporate limits of the City needed for the proper giving of service. There are no
conditions or restrictions on Department’s exercise of its power of eminent domain other
than those imposed on all government entities exercising eminent domain in State.
Department is not required to seek approval from or act through City or State to
exercise its power of eminent domain. Title to any property so acquired remains with
Department.

Department is also granted by State statute the power to levy a special tax upon all
property within the corporate limits of City for the purpose of raising money to pay the
principal of and interest accruing on bonds issued by Department.

Department has exclusive authority under State statute to issue utility district bonds in
the name of City, and may issue such bonds without City’s authorization. These bonds
are an indebtedness of Department as a special taxing district and are not an obligation
or indebtedness of City.

City and District own and operate the System. District was established under City’s
municipal code. City has the power to appoint and remove the members of District’s
board of directors.

District has financed a portion of the System with revenue bonds (the “District Bonds”)
which were authorized by resolution of City and were issued by the District in the name
of the City. The District Bonds are payable from the revenues of the operation of the
System.

Department, City, and District have entered into an agreement (the “Agreement”)
pursuant to State’s interlocal cooperation statute, to form Authority, a non-profit
corporation, to acquire and operate the System. The Agreement provides that Authority
will possess all of the “appropriate and requisite authorizations, powers, functions and
duties” of the three creating entities to allow it to administer and operate the
System. City and District will vest in Authority all of their respective powers and
authority related to the operation of the System (other than their powers of taxation).
Department will transfer all of its relevant powers to Authority, including its eminent
domain, taxing, and regulatory powers, and the Department Board is charged under the
Agreement to use such powers as the board of directors of Authority. Authority will be
authorized to exercise eminent domain powers on its own, without Department’s
approval.
PLR-132892-10 4

While Authority will own the System as a separate entity, the Agreement requires that
Authority be wholly controlled by, and the System solely operated by, Department. The
Department Board will serve as the board of directors of Authority and will have
responsibility for Authority’s budget. Department’s treasurer is responsible to receive,
disburse, and account for all monies of Authority which are required to be segregated
from those of any other utility. Upon dissolution of Authority and after all liabilities of
Authority have been paid, all assets of Authority will be distributed to Department or
such other entity as Department shall determine to be operating for the benefit of the
inhabitants of City.

After Authority was created, and the Department (and Authority) Board adopted an
approving resolution, Department and Authority entered into an asset purchase
agreement (the “Purchase Agreement”) with City and District for the acquisition of the
System assets to be held by Authority. Authority will issue bonds (the “Authority
Bonds”) to pay at least a portion of the purchase price.

Law and Analysis

Political Subdivision

Section 103(a) provides generally that gross income does not include interest on any
State or local bond.

Section 1.103-1(a) provides, in part, that interest upon obligations of a state, territory,
possession of the United States, the District of Columbia, or any political subdivision
thereof (hereinafter collectively or individually called “state or local government unit”) is
not includable in gross income.

Section 1.103-1(b) provides that the term “political subdivision” denotes any division of
any state or local governmental unit that is a municipal corporation or that has been
delegated the right to exercise part of the sovereign power of the unit. As thus defined,
a political subdivision of any state or local governmental unit may or may not, for
purposes of this section, include special assessment districts so created, such as road,
water, sewer, gas, light, reclamation, drainage, irrigation, levee, school, harbor, port
improvement, and similar districts and divisions of these units.

Three generally acknowledged sovereign powers of states are the power to tax, the
power of eminent domain, and the police power. Commissioner of Estate of Alexander
v. Shamberg, 3 T.C. 131 (1944), acq., 1945 C.B. 6, aff’d 144 F.2d 998 (2d Cir. 1944),
cert denied, 323 U.S. 792 (1945). It is not necessary that all three of these powers be
delegated in order to treat an entity as a political subdivision for purposes of the Code.
However, possession of only an insubstantial amount of any or all of the sovereign
powers is not sufficient. All of the facts and circumstances must be taken into
PLR-132892-10 5

consideration, including the public purposes of the entity and its control by a
government. Rev. Rul. 77-164, 1977-1 C.B. 20.

Consideration of these principles as they apply to the facts of this case, leads us to
conclude that Authority is a political subdivision for purposes of § 1.103-1(b). Authority
will be wholly controlled by Department, a political subdivision. The Department Board
will serve as the board of directors of Authority. Department is responsible for receiving,
disbursing, and accounting for all monies of Authority. Upon dissolution of Authority all
remaining assets of Authority will be distributed to Department or such other entity
operating for the benefit of the inhabitants of City as Department shall designate.

Department will transfer its powers to Authority, including its eminent domain, taxing,
and regulatory powers, and the Department Board is charged under the Agreement to
use such powers as the board of directors of Authority. Department’s power of eminent
domain allows it to condemn and hold any real estate within the City or within five miles
of the corporate limits of the City needed for the proper giving of service. Department is
not required to seek approval from or act through City or State to exercise its power of
eminent domain. Authority will be authorized to exercise eminent domain powers on its
own, without Department’s approval.

Authority’s purpose of operating the System is a wholly public purpose.

Related Party

Under § 1.150-1(a)(1), except as otherwise provided, the definitions in § 1.150-1 apply
for all purposes of §§ 103 and 141 through 150. Section 1.150-1(b) provides, in part,
that “related party” means, in reference to a governmental unit or a 501(c)(3)
organization any member of the same controlled group.

A “controlled group” is defined in § 1.150-1(e) as a group of entities controlled directly or
indirectly by the same entity or group of entities. Section 1.150-1(e)(1) provides that the
determination of direct control is made on the basis of all the facts and circumstances.
One entity or group of entities (the controlling entity) generally controls another entity or
group of entities (the controlled entity) if the controlling entity possesses either of the
following rights or powers and the rights or powers are discretionary and non-ministerial
– (i) the right or power both to approve and to remove without cause a controlling
portion of the governing body of the controlled entity; or (ii) the right or power to require
the use of funds or assets of the controlled entity for any purpose of the controlling
entity.

Section 1.150-1(e)(2) states that if a controlling entity controls a controlled entity under
this test, then the controlling entity also controls all entities controlled, directly or
indirectly, by the controlled entity or entities.
PLR-132892-10 6

An entity is not a controlled entity under § 1.150-1(e)(3) if the entity possesses
substantial taxing, eminent domain, and police powers. For example, a city possessing
substantial amounts of each of these sovereign powers is not a controlled entity of the
state.

The issue is whether Authority is related to City or District. Section 1.150-1(e)(3), which
provides an entity is not a “controlled entity” if it possesses substantial taxing, eminent
domain, and police powers, is not applicable in this case, because Authority does not
possess substantial amounts of all three sovereign powers. Thus, in order to determine
whether Authority is controlled by City or District under § 1.150-1(e), we must examine
all the relevant facts and circumstances.

Authority has been created as a separate entity wholly controlled by and solely operated
by Department. Department Board serves as Authority’s board of directors and is
responsible for its budget. Neither City nor District has the power to appoint, remove, or
to cause the removal of, a member of the Department Board. Neither City nor District
has the power to appoint any Trustee. Trustees may be removed from office only for
cause, and only by an order and judgment from a circuit or superior court. In addition,
neither City nor District has control over Department Board’s ability to set rules and
rates. Department Board is granted the power to adopt rules for service and rates for
service, subject only to State approval. While Department Board is required to make
certain accounting and other reports to the City controller, the books, accounts, records
and transactions of Department and of Department Board are only subject to
examination, audit, and supervision by the State Board of Accounts. Neither City nor
District has the right to use the funds or assets of Department or Authority. Accordingly,
based on all the relevant circumstances, neither Department nor Authority is controlled
within the meaning of § 1.150-1(e) by either City or District. As neither City nor District
controls Department or Authority, Authority is not a member of City’s or District’s
controlled group. Therefore, Authority will not be a related party as described in § 1.150-
1(b) to either City or District.

Conclusions

Based on the information submitted and representations made, we conclude that
(1) Authority qualifies as a political subdivision for purposes of § 103, and (2) Authority
is not a related party to either City or District under § 1.150-1(b).

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.
PLR-132892-10 7

In accordance with a Power of Attorney on file with this office, a copy of this letter is
being sent to the authorized representatives of Department.

The ruling contained in this letter is based upon information and representations
submitted by Department and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the materials submitted
in support of the request for a ruling, it is subject to verification upon examination.

                                Sincerely,


                                Associate Chief Counsel
                                (Financial Institutions and Products)



                                By:    Johanna Som de Cerff______________
                                       Johanna Som de Cerff
                                       Senior Technician Reviewer
                                       Branch 5

cc: