State energy corporation qualifies as a political subdivision

Plain-English summary

A state-created public corporation planned to develop natural gas infrastructure for the benefit of state residents. State law gave it unrestricted eminent domain power, the governor appointed and could remove most of its board, state department heads occupied the other board seats, and its property would pass to the state on dissolution. The corporation could contract at arm's length with private energy producers, but represented that any private benefit would be incidental to its public purpose. Applying the 2016 proposed regulations under section 1.103-1 at the corporation's election, the IRS held that it met the sovereign-power, governmental-purpose, and governmental-control requirements for a political subdivision. It therefore was not required to file a federal income tax return.

Ruling snapshot

• Question: Does the state-created energy corporation qualify as a political subdivision and avoid the federal corporate return requirement?
• Outcome: approved
• Key authorities: IRC §§ 103, 6012(a)(2); Prop. Treas. Reg. § 1.103-1(c); Treas. Reg. § 1.6012-2(a)(1)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201741010                                              Third Party Communication: None
Release Date: 10/13/2017                                       Date of Communication: Not Applicable
Index Number: 103.02-00, 103.02-01
                                                               Person To Contact:
--------------------------------                               -----------------, ID No. --------------
--------------------------------------------------------       Telephone Number:
--------------------                                           ----------------------
--------------                                                 Refer Reply To:
------------------------------------------                     CC:FIP:B05
                                                               PLR-108868-17
                                                               Date:
                                                               July 18, 2017




LEGEND:

Corporation                         =         -----------------------------------------------------------------------
----------------------------------------------------------------------

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

Date 1                              =        -------------------

Producers                           =         -----------------------------------------------------------------------
                                             --------------------------------------------------

a                                   =        ----

Dear ---------------

This responds to Corporation’s request for a ruling that it is a political subdivision of
State under section 1.103-1(c) of the Proposed Income Tax Regulations (as defined
below) and does not have to file a federal tax return.

Facts and Representations

Corporation makes the following representations. Corporation was established by State
on Date 1 as an independent public corporation and government instrumentality of
State. The mission of Corporation is to provide State with long-term energy solutions
and to maximize the value of natural gas located in State to make the benefit of those
resources (including associated revenues) available to all State residents.

To carry out its mission, Corporation is authorized to develop (1) a pipeline and related
infrastructure to process and transport natural gas to various communities in-state (the
PLR-108868-17                                 2

“Pipeline Project”), and (2) a larger capacity pipeline with related infrastructure to
process, transport, and liquefy natural gas and to ship excess liquefied natural gas
(“LNG”) out-of-state (the “LNG Project”). The Pipeline Project and the LNG Project are
referred to collectively as the “Projects.” Corporation intends to pursue whichever of the
Projects is most economically feasible, but not both. In addition, Corporation is
authorized to develop other transportation mechanisms to deliver natural gas in-state for
the maximum benefit of all of the people of State.

The assets of the selected Project will be owned by Corporation or one of its
subsidiaries. Most of the natural gas transported and liquefied by the selected Project
will be owned by, or acquired from, private entities that are for-profit oil and gas
producers that have purchased lease rights from State to develop natural gas located in
State (the “Producers”). The Producers are expected to own at least a percent of the
natural gas that is to be monetized through the selected Project.

Corporation, through its subsidiaries, may enter into arm’s-length contracts with private
entities, including the Producers, for the sale of natural gas or LNG. Corporation,
through its subsidiaries, may also enter into arm’s-length tolling arrangements with
private entities, including the Producers, for the sale of services (mainly, transportation
through the constructed pipeline, processing, liquefaction, and storage). Corporation
will solicit long-term contractual commitments from potential customers in order to
ensure adequate financing for the selected Project. Revenue associated with the
Projects, to the extent earned by Corporation and its subsidiaries, will be used to
provide economic benefits and revenues to State and all of its residents.

Corporation is governed by a board of directors (the “Board”) consisting of seven
members: five public members; and two members that are heads of principal
departments of State. The public members are appointed by the governor of State (the
“Governor”) and are subject to confirmation by the State legislature. Public members of
the Board serve staggered five-year terms and can be removed at any time by the
Governor. Vacancies on the Board are subject to confirmation by the State legislature.
Corporation and its subsidiaries are required to annually submit a proposed operating
budget to State for inclusion in the Governor’s annual operating budget.

Corporation is authorized under State law to initiate eminent domain actions, in its own
name, to acquire property in State. This power is equal to, and indistinguishable, from
the power of eminent domain held by State.

Upon dissolution of Corporation, all of its rights and property pass to State.

Corporation chooses to apply the proposed regulations under section 1.103-1 published
on February 23, 2016 (the “Proposed Regulations”), as permitted by the notice of
proposed rulemaking. 81 FR 8870
PLR-108868-17                                  3

Law and Analysis

The Internal Revenue Code does not define the term “political subdivision.” Section
1.103-1(b) of the Income Tax Regulations 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 section 1.103-1(b), 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.

Section 1.103-1(c)(1) of the Proposed Regulations provides in part that the term political
subdivision means an entity that meets each of the requirements of paragraphs (c)(2)
(sovereign powers), (c)(3) (governmental purpose), and (c)(4) (governmental control) of
such section, taking into account all of the facts and circumstances. Entities that may
qualify as political subdivisions include, among others, general purpose governmental
entities, such as cities and counties (whether or not incorporated as municipal
corporations), and special purpose governmental entities, such as special assessment
districts that provide for roads, water, sewer, gas, light, reclamation, drainage, irrigation,
levee, school, harbor, port improvements, and other governmental purposes for a State
or local governmental unit.

Section 1.103-1(c)(2) of the Proposed Regulations provides that an entity meets the
“sovereign powers” requirement if pursuant to a State or local law of general application,
the entity has a delegated right to exercise a substantial amount of at least one of the
following recognized sovereign powers of a State or local governmental unit: the power
of taxation, the power of eminent domain, and police power.

Section 1.103-1(c)(3) of the Proposed Regulations provides that the determination of
whether an entity serves a governmental purpose is based on, among other things,
whether the entity carries out the public purposes that are set forth in the entity’s
enabling legislation and whether the entity operates in a manner that provides a
significant public benefit with no more than incidental private benefit.

Section 1.103-1(c)(4) of the Proposed Regulations provides that the entity meets the
requirement for governmental control if a State or local governmental unit exercises
control over the entity.

Section 1.103-1(c)(4)(i) of the Proposed Regulations provides that for this purpose,
control means an ongoing right or power to direct significant actions of the entity.
Rights or powers may establish control either individually or in the aggregate. Among
rights or powers that may establish control, an ongoing ability to exercise one or more of
the following significant rights or powers, on a discretionary and non-ministerial basis,
PLR-108868-17                                 4

constitutes control: the right or power both to approve and to remove a majority of the
governing body of the entity; the right or power to elect a majority of the governing body
of the entity in periodic elections of reasonable frequency; or the right or power to
approve or direct the significant uses of funds or assets of the entity in advance of that
use. Procedures designed to ensure the integrity of the entity but not to direct
significant actions of the entity are insufficient to constitute control of an entity.
Examples of such procedures include requirements for submission of audited financial
statements of the entity to a higher level State or local governmental unit, open meeting
requirements, and conflicts of interest limitations.

Section 1.103-1(c)(4)(ii) of the Proposed Regulations provides in part that control may
be vested in a State or local governmental unit possessing a substantial amount of each
of the sovereign powers and acting through its governing body or through its duly
authorized elected or appointed officials in their official capacities.

Section 6012(a)(2) of the Code and section 1.6012-2(a)(1) of the Income Tax
Regulations provide that every corporation subject to taxation under Subtitle A is
required to file an income tax return regardless of whether it has taxable income or
regardless of its gross income. However, the filing requirement of section 6012(a)(2)
does not apply to states or their political subdivisions, with respect to activities
conducted directly by them. See Rev. Rul. 78-316, 1978-2 C.B. 304, clarifying Rev. Rul.
77-261, 1977-2 C.B. 45.

Our consideration of the Proposed Regulations, as they apply to the facts of this case,
leads us to conclude that Corporation is a political subdivision for purposes of Section
1.103-1(c) of the Proposed Regulations. Corporation was created pursuant to State
legislation and is controlled by State. Of Corporation’s seven Board members, two are
heads of departments of State and five are appointed, and can be removed, by the
Governor of State. Corporation is also required to submit annually to State a financial
statement and complete report of its business activities. Upon dissolution of
Corporation all remaining assets of Corporation will pass to State.

Under State law, Corporation is granted powers of eminent domain to carry out
authorized purposes. Corporation may initiate eminent domain actions in its own name
without limitation.

Corporation’s purpose of providing State with long-term energy solutions and
maximizing the value of natural gas located in State to make the benefit of those
resources (including associated revenues) available to all State residents is a
governmental purpose. So long as Corporation’s contracts and transactions with
private entities are arm’s-length, any private involvement in and benefit from the
Projects, including any involvement of, or benefit derived by, private entities, including
the Producers, is only incidental to Corporation’s public purpose.
PLR-108868-17                                  5

Conclusion

Under the facts and circumstances of this case and based on the representations made
by Corporation, we conclude that Corporation qualifies as a political subdivision under
Section 1.103-1(c) of the Proposed Regulations. As a political subdivision, Corporation
is not required to file a federal tax return.

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.

In accordance with a Power of Attorney on file with this office, a copy of this letter is
being sent to each of Corporation’s authorized representatives.

The ruling contained in this letter is based upon information and representations
submitted by Corporation 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 & Products)

                                                               /s/
                                           By: _________________________
                                               Timothy L. Jones
                                               Senior Counsel, Branch 5