Hydroelectric authority earns excluded governmental income

Plain-English summary

A county and a governmental agency created an authority to finance hydroelectric-project licensing costs, approve energy contracts, and distribute project revenue. The two political subdivisions exclusively owned and controlled the authority, received residual revenue, and would divide its property on dissolution; private parties benefited only incidentally as vendors or power purchasers. The IRS ruled that the authority performed essential governmental functions and its income accrued to political subdivisions, making the income excludable under § 115(1). It also found the authority met the constituted-authority factors, so bonds it issued on behalf of the governmental units qualified under Treas. Reg. § 1.103-1(b).

Ruling snapshot

• Question: Is the authority's income excluded under § 115(1), and is it a constituted authority empowered to issue governmental obligations?
• Outcome: Approved
• Key authorities: IRC §§ 103(a) and 115(1); Treas. Reg. § 1.103-1(b); Rev. Rul. 57-187

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201442037 Third Party Communication: None
Release Date: 10/17/2014 Date of Communication: Not Applicable
Index Number: 115.00-00, 103.02-02
Person To Contact:
-------------------------------------------------- ------------------------------, ID No. ------------
------------------------------ ----------------
-------------------------- Telephone Number:
------------------- --------------------
----------------------------- Refer Reply To:
CC:FIP:05
PLR-146092-13
Date:
July 11, 2014

Legend

Act = -------------------------------------------

Agreement = ---------------------------------------------------------------------------------
---------------------------------

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

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

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

Agency = --------------------------------------

Project = -----------------------------------------------------------------

Statutes = -------------------------------------------------------

x = --

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

This letter is in response to your request for rulings that (1) the Authority’s income is
derived from the exercise of an essential governmental function and will accrue to the
State or a political subdivision thereof for purposes of § 115(1) of the Internal Revenue
Code; and (2) the Authority is a constituted authority within the meaning of § 1.103-1(b)
of the Income Tax Regulations.

Facts and Representations

The County is a political subdivision of the State. The Agency was created by the Act
as a body politic and corporate. The Agency is empowered by the Act to undertake any
lawful act necessary to ensure sufficient water for the present and future beneficial use
PLR-146092-13 2

of the land and inhabitants within County. The Authority represents that Agency is a
political subdivision of the State.

The Agency owns the Project, which consists of hydroelectric power plants, dams,
tunnels, and public recreational facilities. The Agency operates the Project pursuant to
a license issued by the Federal Energy Regulatory Commission (FERC).

Pursuant to the Statutes, the County and the Agency entered into the Agreement
creating the Authority. The Agreement authorizes the Authority to exercise the powers
of each of the County and the Agency. The purpose of the Authority is to provide
financing for costs required by the FERC licensing process, to approve electrical energy
and related services contracts, and to distribute revenues from those contracts. Among
the powers the Authority can exercise in furtherance of these purposes are the powers
to acquire, to lease, and to sell property. The Agreement and the Statutes authorize the
Authority to issue bonds.

The County and the Agency are the sole members of the Authority. The Authority is
governed by a x member board of directors. Half of those directors are members of the
County’s board of directors, and half are members of the Agency’s board of directors.

The Agreement provides that the Authority receives all revenues from the sale of
electrical energy produced by the Project. The Agreement also establishes priorities for
the expenditure and distribution of those revenues. Under the Agreement, revenues
must first be spent on basic operation and maintenance of the Project, compliance with
contractual and regulatory requirements, maintenance of operating reserves, and
repayment of debt. After those costs are paid, revenues must then be spent on
additions and betterments, such as major improvements, emergency reserves, and
sinking funds for replacements. Finally, any remaining revenues may be distributed
equally to the County and the Agency. Upon dissolution, the Authority’s property will be
divided between the County and the Agency.

Law and Analysis

Income under § 115

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

In Revenue Ruling 77-261, 1977-2 C.B. 45, income from an investment fund,
established by a state under a written declaration of trust for the temporary investment
of cash balances of the state and its participating political subdivisions, was excludable
from gross income for federal income tax purposes under § 115(1). The ruling explains
that the statutory exclusion was 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 a
corporation or other entity engaged in the operation of a public utility or the performance
PLR-146092-13 3

of some governmental function that accrues to either a state or municipality. 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 which are within the ambit of a
sovereign properly to conduct.

In Revenue Ruling 90-74, 1990-2 C.B. 34, the income of an organization formed,
funded, and operated by political subdivisions to pool various risks arising from their
obligations regarding public liability, workers’ compensation, or employees’ health was
excludable from gross income under § 115. In this ruling, private interests did not
participate in the organization, nor did they benefit more than incidentally from the
organization.

The Authority reviews and approves contracts for the sale of electrical energy generated
by the Project, distributes revenues from those contracts, and provides financing for
costs required by the FERC licensing process. Engaging in such activities on behalf of
the County and the Agency constitutes the performance of essential governmental
functions. See Rev. Rul. 90-74 and Rev. Rul. 77-261.

All of the Authority’s income accrues to the County and the Agency, which are political
subdivisions of the State. Revenues exceeding amounts necessary for the operation,
maintenance, and support of the Project and for additions and betterments to the
Project are distributed to the County and the Agency. Upon the Authority’s dissolution,
all of its property will be divided between the County and the Agency. No private
interests participate in, or benefit more than incidentally from, the operation of the
Authority, other than as providers of goods or services or purchasers of electrical
energy. See Rev. Rul. 90-74. We conclude, therefore, that the Authority’s income is
derived from the exercise of an essential governmental function and will accrue to the
State or a political subdivision thereof for purposes of § 115(1).

Constituted Authority

Section 103(a) provides that gross income does not include interest on any state or
local bond. Treas. Reg. § 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 is not includable in gross income. Treas. Reg. § 1.103-1(b) provides
in part that obligations issued by or on behalf of any such governmental unit by a
constituted authority empowered to issue such an obligation are the obligations of such
a unit.

Revenue Ruling 57-187, 1957-1 C.B. 65, holds that bonds issued by an entity are
considered issued on behalf of a political subdivision of the state under the following
conditions: (1) the issuance of bonds is authorized by a specific state statute; (2) the
bond issuance has a public purpose; (3) the governing body of the entity is controlled by
the political subdivision; (4) the entity has the power to acquire, lease, and sell property
and issue bonds in furtherance of its purposes; (5) earnings do not inure to the benefit
PLR-146092-13 4

of private persons; and (6) upon dissolution, title to all bond-financed property reverts to
the political subdivision.

The Agreement and the Statutes authorize the Authority to issue bonds, and its
issuances are for the public purpose of financing costs required by the FERC licensing
process. The County and the Agency, which are political subdivisions, control the
Authority’s governing board. The Agreement empowers the Authority to acquire, lease,
and sell property and to issue bonds in furtherance of its public purposes. Earnings of
the Authority inure solely to the benefit of the County and the Agency. Upon the
Authority’s dissolution, all of its property reverts to the County and the Agency. We
conclude, therefore, that the Authority is a constituted authority within the meaning of
Treas. Reg. § 1.103-1(b).

Conclusion

Based on the information submitted and representations made, we conclude that (1) the
Authority’s income is derived from the exercise of an essential governmental function
and will accrue to the State or a political subdivision thereof for purposes of § 115(1);
and (2) the Authority is a constituted authority within the meaning of Treas. Reg.
§ 1.103-1(b).

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.

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.

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

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

                                   James A. Polfer
                                   Branch Chief
                                   (Financial Institutions & Products)