Municipal utility cooperative's income remains excluded under section 115

Plain-English summary

A state nonprofit cooperative owned by political subdivisions asked the IRS to modify and supersede an earlier ruling about its federal tax treatment. The cooperative pooled resources to procure utility supplies and services for its municipal members, participated in jointly owned facilities, and made some incidental sales to nonmembers. The IRS concluded that these activities performed an essential governmental function, that the income accrued to political subdivisions, and that private interests did not participate or benefit more than incidentally. Its income therefore remained excluded from gross income under IRC § 115(1), including despite the described joint ownership arrangements. Because the cooperative was also an affiliate of a governmental unit under Revenue Procedure 95-48, it was not required to file Form 990. The modification applied retroactively to the date of the earlier ruling because the corrected facts did not change the prior conclusion.

Ruling snapshot

• Question: Did the cooperative's municipal utility activities qualify for section 115 income exclusion, and was it exempt from filing Form 990?
• Outcome: Approved; the modified ruling preserved the income exclusion and confirmed no Form 990 filing requirement
• Key authorities: IRC §§ 115, 501, and 6033; Treas. Reg. §§ 1.141-7 and 1.6033-2; Rev. Proc. 95-48

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201509001 Third Party Communication: None
Release Date: 2/27/2015 Date of Communication: Not Applicable
Index Number: 115.00-00, 115.03-00
Person To Contact:
---------------------- ------------------------, ID No. ------------------
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------------------------------------------- Telephone Number:
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------------------------------------- Refer Reply To:
CC:TEGE:EOEG:EO
PLR-102305-14
Date:
October 22, 2014

Legend

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PLR-102305-14 2

U = -------------------------------------------------------------------------------------------
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Dear ----------------:

This letter is being sent to modify our private letter ruling (PLR 201338029), dated May
23, 2013 (the “PLR”). We are modifying the PLR to correct certain statements under
the headings FACTS and LAW AND ANALYSIS. The PLR contains a ruling that
Company’s income is excludible from gross income under Internal Revenue Code
(“IRC”) § 115 because the income of Company derives from the exercise of an essential
governmental function and will accrue to a state or a political subdivision thereof. In
conjunction with our modification of the PLR, Company requested a ruling that
Company is not required to file Form 990. This ruling modifies and supersedes the
PLR.

We make the following modifications to the PLR:

The last sentence of the sixth full paragraph under the heading FACTS is deleted in its
entirety.

The ninth full paragraph under the heading FACTS is modified to read as follows:

    Company from time-to-time generates revenues from sales to non-
    members. Savings or positive net margin, 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 Company. Non-member sales have
    generally included (i) sales of T assets; (ii) sales of U with respect to
    supply contracts; (iii) miscellaneous transactions (swaps/trade and
    “book out” transactions); and (iv) transactions resulting from AA
    mandates. With respect to these sales to non-members, Company

PLR-102305-14 3

  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.

The first sentence of the eleventh full paragraph under the heading FACTS is modified
to become two sentences that read as follows No private interests participate in the
operation of Company. Except for the incidental benefit received by nonmembers as
described above, no private interests benefit from the operation of Company other than
for reasonable payment as providers of goods or services.

The second sentence of the third full paragraph under the heading LAW AND
ANALYSIS is modified to become two sentences that read as follows: The revenue
ruling states that the income of such an 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. The benefit to the employees of the insurance
coverage obtained by the member political subdivisions was deemed incidental to the
public benefit.

The second sentence of the fifth full paragraph under the heading LAW AND ANALYSIS
is modified to read as follows: Private interests do not participate in Company or benefit
more than incidentally (e.g., the benefit to nonmembers from the sales discussed above
or as providers of goods or services) from the operation of Company.Under the heading
LAW AND ANALYSIS, we also added discussion regarding the request to be excluded
from filing Form 990.

The PLR, as modified, reads as follows:

FACTS

Company is a State non-profit corporation and, by terms of Company’s A, only
municipalities owning or initiating B utility system may be members. Company has over
V members. All of Company’s present members are political subdivisions that own
and/or operate C utility systems.

Company has two classes of members, D members and E members. D members must
be political subdivisions within the meaning of Treas. Reg. § 1.103-1 and own or be in
the process of initiating B utility system. E members must be (i) political subdivisions
within the meaning of Treas. Reg. § 1.103-1, such as some public universities, and
consume W, but the entity may also distribute such F to others or the entity qualifies as
a D member, and (ii) be geographically remote from Company’s general area of
operations such that in Company’s sole opinion, Company cannot economically provide
services other than G to such member. In the event of dissolution of Company, E
members share in the distribution of assets (after the payment of debts and the
PLR-102305-14 4

repayment of initial capital contributions and membership fees, including dues) on the
same basis as D members.

The Internal Revenue Service (“IRS”) issued Company a determination letter that it was
exempt from federal income taxation because it was a cooperative described in IRC §
501(c)(12) on Date X . Company is a cooperative H, 85 percent or more of the income
of which consists of amounts collected from members for the sole purpose of meeting
losses and expenses within the meaning of IRC § 501(c)(12). Company represents that
it has never been in violation of the 85/15 requirement. The IRS also previously issued
Company a favorable private letter ruling that its income was excluded from gross
income within the meaning of IRC § 115 on Date Y, and a favorable letter ruling that
Company is an instrumentality within the meaning of IRC § 141 on Date Z.

Company is organized to help its members in procuring economical and reliable
wholesale I on an individual basis and on a “pool” basis for groups of members.
Company also arranges for and provides technical services and training and safety
training for members, acts as a clearinghouse for information, and assists members with
project financings and telecommunication and other utility related issues. Company
also coordinates “mutual aid” among members so J crews from members can be
voluntarily dispatched to other members to assist in emergency or disaster situations.
While the scope and nature of the services provided by Company may evolve over time
as the needs of members change, they will remain consistent with Company’s
governmental purposes.

Company is governed by a board of trustees consisting of twenty of its members. No
individuals, non-member municipalities, or other entities or organizations are eligible to
serve as trustees. Members elected as trustees appoint an individual to represent them
on the board. The president and general counsel serve as nonvoting, ex officio,
trustees. Presently, Company has twenty trustees, twelve elected from member service
groups and eight elected at-large by members. The trustees serve three-year
staggered terms. In the event of a vacancy of an at-large trustee, the remaining
trustees fill such vacancy until the next members meeting from among the members of
either D or E, according to the open seat. At the next members meeting after such
vacancy, the same shall be filled for the unexpired term by an at-large election. In the
event of a vacancy of a service group trustee, the vacancy shall be filled at a special
caucus of the service group for the purpose of electing its representative.

Company has one wholly-owned for-profit subsidiary, K and is the sole member of two
active limited liability companies, L and M, both of which are treated as disregarded
entities for federal tax purposes. K was formed to provide N services to municipalities in
State. Currently, its services are limited to providing aggregation-consulting services to
municipalities.
PLR-102305-14 5

Company has undertaken a substantial number of O-related projects with one or more
of its members. These projects are either owned by Company or jointly-owned by
Company’s members. The members determine if and the extent to which they wish to
participate in each project.

Company has entered into two separate projects involving joint ownership
arrangements. Through L, Company has a joint ownership interest in P, the Q, and,
through M, Company has a joint ownership interest in R, the S. In each of these
projects, each owner has an “undivided ownership interest” in the project. Each of the
co-owners effectively owns a ratable portion of the entire facility (and each of its
components) and is responsible for its ratable share of the capital and operating and
maintenance costs of the facility and is also entitled to a ratable share of the J output of
the facility. Each co-owner has issued its own debt (rather than a joint issuance of debt)
or used some other means to raise its share of the capital cost of the facility.

Company from time-to-time generates revenues from sales to non-members.
Savings or positive net margin, 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
Company. Non-member sales have generally included (i) sales of T assets;
(ii) sales of U with respect to supply contracts, (iii) miscellaneous transactions
(swap/trades and “book out” transactions, and (iv) transactions resulting from
AA mandates. With respect to these sales to non-members, Company
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.

Including investment income, the income of Company also consists of capital
contributions and dues from members, revenue from the sales of power to members,
the payment by members to Company of consulting fees for technical services and
training, operating as a clearinghouse for information and assisting members with
project financings and telecommunication and other utility related issues, revenue
derived through Company’s for-profit subsidiary, K, and revenue from incidental non-
member sales. The project financings provide a cost-effective manner for members to
finance J utility projects, whereby Company issues tax-exempt debt on behalf of
participant member communities. All annual revenues in excess of expenses of
Company accrue to the benefit of its members because they are either applied to
reduce costs of services to members or are treated as increases to members’
patronage capital.

No private interests participate in the operation of Company. Except for the incidental
benefit received by nonmembers as described above or for reasonable payment as
providers of goods or services, no private interests benefit from the operation of
Company. The A provide that upon dissolution or liquidation of Company any assets
PLR-102305-14 6

remaining after payment of all debts and initial capital contributions of members shall be
disposed of (i) by refund in order of receipt of membership fees, including dues paid by
members, and (ii) remaining assets, if any, shall be distributed to members and former
members on the basis of their “patronage” while they were members. Upon dissolution
the assets revert to entities that are political subdivisions.

LAW AND ANALYSIS

IRC §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.

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 IRC § 115(1), 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 IRC §115(1) because the organization is performing an essential
governmental function. The revenue ruling states that the income of such an
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.
The benefit to the employees of the insurance coverage obtained by the member
political subdivisions was deemed incidental to the public benefit.

IRC § 6033(a) generally provides that every organization exempt from tax under IRC §
501(a) shall file an annual return stating its gross income, receipts and disbursements
and such other information as the regulations require. IRC § 6033(a)(2)(B) provides that
the Secretary may relieve any organization from filing such return when he determines
that such filing is not necessary to the efficient administration of the internal revenue
laws.

Treas. Reg. § 1.6033-2(a)(2)(i) provides that every organization exempt from taxation
under section 501(a) and required to file a return under IRC § 6033 shall file its annual
PLR-102305-14 7

return on Form 990.

Rev. Proc. 95-48, 1995-2 C.B. 418, exempts an organization that is an affiliate of a
governmental unit from the requirement of filing Form 990, Return of Organization
Exempt From Income Tax. Section 4.02 of Rev. Proc. 95-48 provides that an
organization is treated as an affiliate of a governmental unit if it is described in IRC §
501(c) and it meets the requirements of either Section 4.02(a) or (b). Section 4.02(a)(i)
of Rev. Proc. 95-48 states that an organization is treated as an affiliate of a
governmental unit if it has a ruling or determination from the Service that its income,
derived from activities constituting the basis for its exemption under IRC § 501(c), is
excluded from gross income under IRC § 115.

Company procures economical and reliable wholesale I. Providing for a pooling of
resources to procure F supplies and transmission services for municipalities and their
residents constitutes the performance of an essential governmental function within the
meaning of IRC §115(1). See Rev. Rul. 77-261 and Rev. Rul. 90-74.

In addition, the income of Company accrues to the members. Private interests do not
participate in Company or benefit more than incidentally (e.g., the benefit to non-
members from the sales discussed above or as providers of goods or services) from the
operation of Company The Company dedicates its assets and income exclusively for
the benefit of the members and their mutual benefit. See Rev. Rul. 90-74.

On June 25, 2012, the IRS issued a general information letter concluding that the fact
that an entity is the co-owner of an electric generating plant with a non-governmental
co-owner will not prevent that governmental entity from satisfying the requirements of
IRC § 115 provided that the ownership interest is consistent with the description of such
an arrangement in Example 1 of Treas. Reg. § 1.141-7(i). That example states that a
co-ownership structure does not result in “private business use” by the
nongovernmental co-owner of the governmental co-owner’s tax-exempt bond financed
portion of the facility. Specifically, the example describes the ownership structure as
joint ownership as tenants in common, with each of the participants sharing in the
ownership, output, and operating expenses of the facility in proportion to its contribution
to the cost of the facility. Company’s joint ownership interests in the Q and the S, O
facilities, are consistent with the arrangement described in section 1.141-7(i), Example
1.

Q involves (1) joint ownership as tenants in common, (2) each of the co-owners shares
in the ownership, output and operating expenses of the facility in proportion to its
contribution to the cost of the facility, (3) Company’s bonds related to these facilities are
secured by the revenue to be derived from its share of the annual output of the facility,
and (4) other than Company’s members, no person will make payments that will result
in a transfer of the burdens of paying the debt service on Company’s bonds that were
used, directly or indirectly, to provide Company’s share of the facility.
PLR-102305-14 8

A similar conclusion applies to S: (1) the third party interest is substantively similar to a
joint ownership interest but provides the third party with a lesser interest (when
compared to co-ownership) in that facility through a BB purchase contract, (2) each
participant shares in the output and operating expenses of the facility in proportion to
their contribution to the cost of the facility, (3) Company’s bonds related to these
facilities are secured by the revenue to be derived from its share of the annual output of
the facility, and (4) other than Company’s members, no person will make payments that
will result in a transfer of the burdens of paying the debt service on Company’s bonds
that were used, directly or indirectly, to provide Company’s share of the facility.
Accordingly, the fact that Company is the co-owner of O facilities with non-governmental
co-owners does not prevent Company from satisfying the requirements of IRC § 115.

Company is an affiliate of a governmental unit within the meaning of Section 4.02(a)(i)
of Rev. Proc. 95-48.

Based on the information and representations submitted on behalf of Company, we
conclude that:

1. Because the income Company derives is from the exercise of an essential
   governmental function and will accrue to a state or a political subdivision thereof,
   Company’s income is excludable from gross income under IRC §115(1).

2. Because Company is an affiliate of a governmental unit within the meaning of
   Section 4.02(a)(i) of Rev. Proc. 95-48, Company is not required to file Form 990.

No opinion is expressed concerning the Federal tax consequences under any IRC
provision other than the one specifically cited above and in the PLR.

This modification relates to our statement of certain facts and applies retroactively to
May 23, 2013, the date of the PLR, because the changed statement of facts does not
affect our previous conclusion. Except as noted above, the analysis and conclusion of
the PLR remain the same.

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

This modification letter, as well as the PLR, is directed only to you, the taxpayer that
requested it. IRC § 6110(k)(3) 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.
PLR-102305-14 9

A copy of this letter and the PLR must be attached to any income tax return to which
they are relevant. Alternatively, taxpayers filing their returns electronically may satisfy
this requirement by attaching a statement to their return that provides the date and
control number of this modification letter and the PLR.

The ruling contained in this modification letter and the PLR is 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 ruling, it is subject to verification on examination.

                                   Sincerely,



                                   Casey Lothamer
                                   Senior Technician Reviewer, Exempt
                                   Organizations
                                   (Tax Exempt & Government Entities)