Federal Register: September 23, 2002 (Volume 67, Number 184)
DOCID: FR Doc 02-24137
DEPARTMENT OF THE TREASURY
Treasury Department
CFR Citation: 26 CFR Part 1
RIN ID: RIN 1545-AY71
TD ID: [TD 9016]
NOTICE: Part VI
DOCUMENT ACTION: Final regulations.
SUBJECT CATEGORY:
Obligations of States and Political Subdivisions
DATES: Effective Date: These regulations are effective November 22, 2002.
Applicability Date: For dates of applicability, see Sec. 1.14115 of these regulations.
DOCUMENT SUMMARY:
This document contains final regulations on the definition of private activity bonds applicable to taxexempt bonds issued by state and local governments for output facilities. These regulations affect issuers of taxexempt bonds and provide needed guidance for applying the private activity bond restrictions to output facilities.
SUMMARY:
Treasury Department, Internal Revenue Service,
SUPPLEMENTAL INFORMATION
Background
This document amends the Income Tax Regulations (26 CFR part 1)
under section 141 by providing special rules for taxexempt bonds
issued for output facilities. On January 18, 2001, temporary
regulations (TD 8941) (the temporary regulations) were published in the
Federal Register (66 FR 4661) to provide guidance under the Internal
Revenue Code of 1986 regarding, among other things, (a) the application
of the private activity bond tests under section 141(b)(1) and (2) to
output contracts for output facilities; and (b) the application of the
$15 million limit under section 141(b)(4) to output facility
financings. A notice of proposed rulemaking (REG11499899) cross
referencing the temporary regulations was published in the Federal
Register on the same day (66 FR 4754). On July 24, 2001, the IRS held a
public hearing on the proposed regulations. Written comments responding
to the notice of proposed rulemaking were also received. After
consideration of all the comments, the proposed regulations are adopted
as amended by this Treasury decision and the temporary regulations are removed. The revisions are discussed below.
Explanation of Provisions
A. Sec. 1.1417 Special Rules for Output Facilities
1. Benefits and Burdens Test
The temporary regulations contain a benefits and burdens test for determining whether the purchase of output of an output facility is taken into account under the private business tests. In particular, the temporary regulations provide that the purchase by a nongovernmental person of available output of an output facility is taken into account under the private business tests if it has the effect of transferring substantial benefits of owning the facility and substantial burdens of paying the debt service on bonds used to finance the facility. Under this test, an output contract transfers substantial benefits of owning a facility if it gives the purchaser (directly or indirectly) rights to capacity of the facility on a basis that is preferential to the rights of the general public. An output contract transfers substantial burdens of paying debt service under this test to the extent that the issuer reasonably expects that it is substantially certain that payments will be made under the terms of the contract (disregarding default, insolvency, or other similar circumstances).
Commentators were generally critical of the benefits and burdens test in the temporary regulations. Some commentators stated that preferential rights is not an adequate concept for determining whether substantial benefits of ownership are passed through an output contract. Some commentators suggested that a substantial certainty of payment by a purchaser does not necessarily constitute a transfer of substantial burdens of paying debt service. Other commentators recommended that any sale of output by a municipal utility outside of its traditional service territory should result in private business use.
The final regulations amend the benefits and burdens test. Under the revised provision, an output contract is taken into account under the private business tests if it has the effect of transferring to a nongovernmental person the benefits of owning the facility and the burdens of paying the debt service on bonds issued to finance the facility. This test is met if a nongovernmental person agrees to purchase available output of a facility pursuant to (1) a take contract (that is, a contract under which the purchaser agrees to pay for the output if the facility is capable of providing it), or (2) a take or pay contract (that is, a contract under which the purchaser agrees to pay for the output, whether or not the facility is capable of providing it). In addition, as discussed below, certain requirements contracts may satisfy the benefits and burdens test. The final regulations define requirements contract as an output contract, other than a take contract or a take or pay contract, under which a nongovernmental person agrees to purchase all or part of its output requirements.
2. Requirements Contracts
The temporary regulations provide that a requirements contract under which a nongovernmental person agrees to purchase all or part of its output requirements is taken into account under the private business tests to the extent that, based on all the facts and circumstances, it meets the benefits and burdens test in those regulations. Relevant factors in making this determination include whether the purchaser's customer base has significant indicators of stability, whether the contract covers historical (rather than only projected) requirements, and whether the purchaser agrees not to construct or acquire other resources. A requirements contract that is not a sale at wholesale (a retail requirements contract) generally does not meet the benefits and burdens test in the temporary regulations, except to the extent it obligates the purchaser to have requirements or to make payments that are not contingent on its requirements. Reasonable and customary damages and termination provisions do not cause a requirements contract to meet the benefits and burdens test under the temporary regulations.
Most commentators were critical of the treatment of requirements contracts in the temporary regulations. Some commentators stated that the factors for analyzing requirements contracts are not administrable and do not necessarily indicate whether a purchaser has acquired substantial benefits of ownership or burdens of debt service. Other commentators requested that the regulations be amended to specify that requirements contracts with power marketers or with purchasers located outside the service territory of a municipal utility result in private business use.
The final regulations provide two rules under which a requirements
contract may satisfy the benefits and burdens test. First, a
requirements contract (retail or wholesale) generally meets the
benefits and burdens test to the extent that it contains contractual terms that obligate the purchaser to
[[Page 59757]]
make payments that are not contingent on the output requirements of the
purchaser or that obligate the purchaser to have output requirements.
Second, the final regulations continue to apply a facts and
circumstances approach for wholesale requirements contracts, but
provide simplified factors and two safe harbors. Under this approach,
the following factors tend to establish that a wholesale requirements
contract meets the benefits and burdens test: (1) The term of the
contract is substantial relative to the term of the issue and (2) the
amount of output to be purchased represents a substantial portion of
the available output. A wholesale requirements contract does not meet
the benefits and burdens test under the facts and circumstances
approach if it satisfies one of the following safe harbors: (1) Its
term does not exceed the lesser of five years or 30 percent of the term
of the issue or (2) the amount of output to be purchased does not
exceed five percent of the available output of the facility. 3. Pledged Contracts
Under the temporary regulations, payments under an output contract that is pledged as security for an issue are taken into account under the private business tests even if they are not substantially certain to be made. A contract is pledged for this purpose only if the bond documents prohibit substantial amendments of the contract without the consent of bondholders.
Some commentators suggested that this provision adds undue complexity and is unnecessary in light of the benefits and burdens test. The final regulations adopt this comment and delete the provision.
4. Exception for Small Purchases of Output
The temporary regulations provide that an output contract is not taken into account under the private business tests if the average annual payments under the contract that are substantially certain to be made do not exceed 0.5 percent of the average annual debt service on all outstanding taxexempt bonds issued to finance the facility, determined as of the effective date of the contract.
Some commentators recommended that the 0.5 percent threshold be increased to one percent, and that the exception refer to guaranteed minimum, rather than substantially certain, payments. Other commentators recommended that the exception be deleted. The final regulations increase the 0.5 percent threshold to one percent and specify that all payments to be made under the contract are taken into account.
5. Exception for ShortTerm Sales of Output
The temporary regulations contain an exception under which an output contract with a nongovernmental person is not taken into account under the private business tests if: (1) The term of the contract, including all renewal options, does not exceed one year; (2) the compensation under the contract is based on generally applicable and uniformly applied rates or represents a negotiated, fair market price; and (3) the facility is not financed for a principal purpose of serving that nongovernmental person.
Most commentators recommended that this exception be expanded to permit contracts of a longer duration. These commentators stated that longerterm contracts are required in order to transfer benefits of ownership and burdens of debt service with respect to an output facility. Other commentators suggested that the exception should be narrower in scope. These commentators recommended that the exception take into account the entire anticipated period of ongoing sales, irrespective of the term of any contracts or renewal options.
The final regulations retain and amend the exception for shortterm output sales. In order to exclude from the private business tests output contracts that do not transfer the benefits of ownership and the burdens of debt service, the final regulations increase the oneyear period to three years.
6. Exception for Swapping and Pooling Arrangements
The temporary regulations provide that certain agreements to swap or pool output do not result in private business use to the extent that: (1) The swapped output is reasonably expected to be approximately equal in value, determined over periods of one year or less; and (2) the agreement is entered into for a qualifying purpose, such as enhancing reliability.
Some commentators recommended that the exception be expanded to apply to transactions in which the value of the swapped output is not approximately equal, but the governmental person is a net importer of power. The final regulations do not adopt this recommendation because such transactions may not in substance constitute power swaps, and are more appropriately analyzed under the benefits and burdens test.
The final regulations retain the exception for swapping and pooling arrangements, but increase the oneyear period to three years. 7. Special Rule for Facilities With Significant Unutilized Capacity
The temporary regulations provide that, if an issuer reasonably expects on the issue date that persons that are treated as private business users will purchase more than 20 percent of the actual output of the facility, the Commissioner may determine the number of units produced or to be produced by the facility in one year on a reasonable basis other than by reference to nameplate capacity, such as the average expected annual output of the facility.
Commentators suggested that the 20 percent threshold be increased
to 30 percent in order to be consistent with longstanding IRS ruling
positions that predated the issuance of regulations under section 141
for output facilities (e.g., Rev. Proc. 893 (19891 C.B. 761)). The
final regulations adopt this comment and change the 20 percent threshold to 30 percent.
8. Special Exception for Sales of Output Attributable to Excess Generating Capacity Resulting From Open Access
The temporary regulations contain an exception to private business use for certain purchases of output of an electric generating facility if: (1) The contract term does not exceed three years; (2) the issuer does not utilize taxexempt financing to increase the generating capacity of its system by more than three percent during the contract term; (3) the governmental owner offers certain nondiscriminatory, open access transmission tariffs; (4) all of the output sold is attributable to excess capacity resulting from the offer of the open access tariffs; and (5) all payments received by the governmental owner under the contract (other than the portion allocable to operation and maintenance expenses described in Sec. 1.1414(c)(2)(C)) are applied as promptly as is reasonably practical to redeem taxexempt bonds in a manner consistent with Sec. 1.14112.
Some commentators stated that this exception contains overly
restrictive requirements that significantly limit its usefulness. These
commentators recommended that the exception be expanded to apply to:
(1) Sales in anticipation of open access or retail competition; (2)
sales to native load customers if open access is in effect or
reasonably expected to commence within a reasonable time period; and (3) contracts with terms in excess of three
[[Page 59758]]
years. These commentators also requested clarification regarding the
requirement to redeem bonds, the extent to which the rules in Sec.
1.14112 apply, and the limitations on taxexempt financing during the contract term.
These suggested changes raise a number of administrability issues.
For example, in many cases it may be difficult to predict the nature
and extent of an issuer's future participation in open access or to
determine whether a particular sale is made in anticipation of open
access. In light of these administrability concerns and the expansion
of the shortterm contract exception to three years as described above,
the final regulations delete the special exception for excess capacity related sales.
9. Special Rules for Electric Output Facilities Used To Provide Open Access
Under the temporary regulations, the use of electric generation, transmission or distribution facilities by a nongovernmental person may result in private business use under the benefits and burdens test. In addition, the use of electric facilities under arrangements other than output contracts may constitute private business use under the general rules of Sec. 1.1413.
The temporary regulations do not contain specific provisions for determining whether the use of electric output facilities by a regional transmission organization (RTO), independent system operator (ISO) or other independent transmission operator results in private business use. However, the preamble to the temporary regulations states that the rules for management contracts under section 141, including Revenue Procedure 9713 (19971 C.B. 632), apply in this regard.
Commentators stated that the management contract guidelines in Revenue Procedure 9713 are not welltailored to address the use of electric facilities by an RTO or an ISO. They requested additional guidance concerning the circumstances in which an RTO or an ISO will not be treated as a private business user. The final regulations provide that a contract for the operation of an electric transmission facility by an independent entity, such as an RTO or an ISO (independent transmission operator), does not result in private business use of the facility if: (1) The facility is owned by a governmental person; (2) the operation of the facility by the independent transmission operator is approved by the Federal Energy Regulatory Commission (FERC) under provisions of the Federal Power Act (16 U.S.C. 791a through 821c) (or by a state authority under comparable provisions of state law); (3) the independent transmission operator's compensation is not based on a share of net profits from the facility; and (4) the independent transmission operator does not bear risk of loss of the facility.
The temporary regulations contain two special exceptions under which certain actions involving electric transmission or distribution facilities are not treated as deliberate actions under Sec. 1.141 2(d). The first exception applies to certain contracts entered into in response to, or in anticipation of, an order by the FERC to wheel power under the Federal Power Act, or by a state authority under comparable state law. The second exception applies to certain actions to implement the offering of nondiscriminatory, open access tariffs in a manner consistent with certain FERC rules under the Federal Power Act or comparable state law. The final regulations retain these special exceptions.
Commentators requested additional guidance regarding the
circumstances in which electric transmission and distribution
facilities that are available for use on a nondiscriminatory, open
access basis will not be used for a private business use. The final
regulations provide that the use of an electric transmission or
distribution facility by a nongovernmental person pursuant to an output
contract does not result in private business use if: (1) The facility
is owned by a governmental person; (2) the facility is available for
use on a nondiscriminatory, open access basis (a transmission facility
meets this requirement if it is operated by a qualifying independent
transmission operator); and (3) the facility is not financed for a principal purpose of serving that nongovernmental person.
B. Sec. 1.1418 $15 Million Limitation for Output Facilities
The temporary regulations provide guidance on the special $15 million limitation on output facilities of section 141(b)(4). In general, this limitation is based on the nonqualified amount of an issue or issues that finance a single project.
The temporary regulations provide that facilities having different purposes or serving different customer bases are not ordinarily part of the same project. For example, a peaking unit and a baseload unit generally are not part of the same project.
The temporary regulations also provide that, in the case of generation and related facilities, project means property located at the same site. However, separate generating units are not part of the same project if one unit is reasonably expected, on the issue date of each issue that finances the facilities, to be placed in service more than three years before the other.
Some commentators noted that there is an ambiguity in the temporary regulations regarding whether a peaking unit and a baseload unit that are located at the same site and placed in service within the same threeyear period are part of the same project. The final regulations clarify that a peaking unit and a baseload unit generally are not part of the same project, even if they are located at the same site and placed in service within the same threeyear period.
C. Need for Final Regulations
Congress passed the Energy Policy Act of 1992, Public Law 102486 (106 Stat. 2776), to encourage restructuring of the electric power industry. Since that time, the FERC and many states have adopted policies to provide open access to transmission and distribution facilities. Treasury and the IRS are aware that these initiatives have caused many changes in the electric power industry, and that restructuring efforts are ongoing. The temporary regulations were published in order to provide immediate guidance under section 141 regarding the effect on the taxexempt status of bonds of certain restructuring transactions necessary for utilities to participate in a restructured electric utility industry.
Commentators stated that the lack of final regulations addressing these issues has hindered public power systems in undertaking longterm planning. Commentators also stated that uncertainty regarding the characterization under the private business tests of certain open access transactions has hampered participation by public power systems in open access plans. The final regulations are being issued at this time in order to address these concerns, notwithstanding that restructuring initiatives continue to evolve. It is anticipated that the special rules in the final regulations for open access transactions will not result in a significant increase in the volume of taxexempt bonds for output facilities. In the event that such an increase does occur, Treasury and the IRS may reconsider relevant aspects of the regulations and propose additional limitations on the use of taxexempt financing for such facilities.
Effective Dates
The final regulations apply to bonds sold on or after November 22, 2002.
[[Page 59759]]
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the rule does not impose a collection of information on small entities, the provisions of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.) do not apply.
Drafting Information
The principal authors of these regulations are Bruce M. Serchuk and Rose M. Weber, Office of Chief Counsel (Taxexempt and Government Entities), Internal Revenue Service, and Stephen J. Watson, Office of Tax Legislative Counsel, Department of the Treasury. However, other personnel from the IRS and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements. Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows: PART 1INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.1410 is amended by removing the entries for
Sec. Sec. 1.1417T, 1.1418T and 1.14115T and adding entries to the
table in numerical order for Sec. Sec. 1.1417, 1.1418 and 1.141 15(f) through (i) to read as follows:
Sec. 1.1410 Table of contents.
* * * * *
Sec. 1.1417 Special rules for output facilities.
(a) Overview.
(b) Definitions.
(1) Available output.
(2) Measurement period.
(3) Sale at wholesale.
(4) Take contract and take or pay contract.
(5) Requirements contract.
(6) Nonqualified amount.
(c) Output contracts.
(1) General rule.
(2) Take contract or take or pay contract.
(3) Requirements contract.
(4) Output contract properly characterized as a lease.
(d) Measurement of private business use.
(e) Measurement of private security or payment.
(f) Exceptions for certain contracts.
(1) Small purchases of output.
(2) Swapping and pooling arrangements.
(3) Shortterm output contracts.
(4) Certain conduit parties disregarded.
(g) Special rules for electric output facilities used to provide open access.
(1) Operation of transmission facilities by nongovernmental persons.
(2) Certain use by nongovernmental persons under output contracts. (3) Ancillary services.
(4) Exceptions to deliberate action rules.
(5) Additional transactions as permitted by the Commissioner. (h) Allocations of output facilities and systems.
(1) Facts and circumstances analysis.
(2) Illustrations.
(3) Transmission and distribution contracts.
(4) Allocation of payments.
(i) Examples.
Sec. 1.1418 $15 million limitation for output facilities. (a) In general.
(1) General rule.
(2) Reduction in $15 million output limitation for outstanding issues.
(3) Benefits and burdens test applicable.
(b) Definition of project.
(1) General rule.
(2) Separate ownership.
(3) Generating property.
(4) Transmission and distribution.
(5) Subsequent improvements.
(6) Replacement property.
(c) Examples.
* * * * *
Sec. 1.14115 Effective dates.
* * * * *
(f) Effective dates for certain regulations relating to output facilities.
(1) General rule.
(2) Transition rule for requirements contracts.
(g) Refunding bonds for output facilities.
(h) Permissive retroactive application.
(i) Permissive application of certain regulations relating to output facilities.
* * * * *
Par. 3. Section 1.1412 is amended by revising the last sentence of paragraph (d)(3)(ii)(B) to read as follows:
Sec. 1.1412 Private activity bond tests.
* * * * *
(d) * * *
(3) * * *
(ii) * * *
(B) * * * See Sec. 1.1417(g)(4).
* * * * *
Par. 4. Section 1.1417 is added to read as follows: Sec. 1.1417 Special rules for output facilities.
(a) Overview. This section provides special rules to determine
whether arrangements for the purchase of output from an output facility
cause an issue of bonds to meet the private business tests. For this
purpose, unless otherwise stated, water facilities are treated as
output facilities. Sections 1.1413 and 1.1414 generally apply to
determine whether other types of arrangements for use of an output
facility cause an issue to meet the private business tests.
(b) Definitions. For purposes of this section and Sec. 1.1418, the following definitions and rules apply:
(1) Available output. The available output of a facility financed
by an issue is determined by multiplying the number of units produced
or to be produced by the facility in one year by the number of years in the measurement period of that facility for that issue.
(i) Generating facilities. The number of units produced or to be
produced by a generating facility in one year is determined by
reference to its nameplate capacity or the equivalent (or where there
is no nameplate capacity or the equivalent, its maximum capacity),
which is not reduced for reserves, maintenance or other unutilized capacity.
(ii) Transmission and other output facilities(A) In general. For
transmission, distribution, cogeneration, and other output facilities,
available output must be measured in a reasonable manner to reflect capacity.
(B) Electric transmission facilities. Measurement of the available
output of all or a portion of electric transmission facilities may be
determined in a manner consistent with the reporting rules and
requirements for transmission networks promulgated by the Federal
Energy Regulatory Commission (FERC). For example, for a transmission
network, the use of aggregate load and load share ratios in a manner
consistent with the requirements of the FERC may be reasonable. In
addition, depending on the facts and circumstances, measurement of the
available output of transmission facilities using thermal capacity or transfer capacity may be reasonable.
(iii) Special rule for facilities with significant unutilized capacity. If an issuer reasonably expects on the issue
[[Page 59760]]
date that persons that are treated as private business users will
purchase more than 30 percent of the actual output of the facility
financed with the issue, the Commissioner may determine the number of
units produced or to be produced by the facility in one year on a
reasonable basis other than by reference to nameplate or other
capacity, such as the average expected annual output of the facility.
For example, the Commissioner may determine the available output of a
financed peaking electric generating unit by reference to the
reasonably expected annual output of that unit if the issuer reasonably
expects, on the issue date of bonds that finance the unit, that an
investorowned utility will purchase more than 30 percent of the actual
output of the facility during the measurement period under a take or
pay contract, even if the amount of output purchased is less than 10
percent of the available output determined by reference to nameplate
capacity. The reasonably expected annual output of the generating
facility must be consistent with the capacity reported for prudent reliability purposes.
(iv) Special rule for facilities with a limited source of supply.
If a limited source of supply constrains the output of an output
facility, the number of units produced or to be produced by the
facility must be determined by reasonably taking into account those
constraints. For this purpose, a limited source of supply shall include
a physical limitation (for example, flow of water), but not an economic
limitation (for example, cost of coal or gas). For example, the
available output of a hydroelectric unit must be determined by
reference to the reasonably expected annual flow of water through the unit.
(2) Measurement period. The measurement period of an output
facility financed by an issue is determined under Sec. 1.1413(g).
(3) Sale at wholesale. A sale at wholesale means a sale of output to any person for resale.
(4) Take contract and take or pay contract. A take contract is an
output contract under which a purchaser agrees to pay for the output
under the contract if the output facility is capable of providing the
output. A take or pay contract is an output contract under which a
purchaser agrees to pay for the output under the contract, whether or
not the output facility is capable of providing the output.
(5) Requirements contract. A requirements contract is an output
contract, other than a take contract or a take or pay contract, under
which a nongovernmental person agrees to purchase all or part of its output requirements.
(6) Nonqualified amount. The nonqualified amount with respect to an issue is determined under section 141(b)(8).
(c) Output contracts(1) General rule. The purchase pursuant to a
contract by a nongovernmental person of available output of an output
facility (output contract) financed with proceeds of an issue is taken
into account under the private business tests if the purchase has the
effect of transferring the benefits of owning the facility and the
burdens of paying the debt service on bonds used (directly or
indirectly) to finance the facility (the benefits and burdens test).
See paragraph (c)(4) of this section for the treatment of an output
contract that is properly characterized as a lease for Federal income
tax purposes. See paragraphs (d) and (e) of this section for rules
regarding measuring the use of, and payments of debt service for, an
output facility for determining whether the private business tests are
met. See also Sec. 1.1418 for rules for when an issue that finances
an output facility (other than a water facility) meets the private
business tests because the nonqualified amount of the issue exceeds $15 million.
(2) Take contract or take or pay contract. The benefits and burdens
test is met if a nongovernmental person agrees pursuant to a take
contract or a take or pay contract to purchase available output of a facility.
(3) Requirements contract(i) In general. A requirements contract
may satisfy the benefits and burdens test under paragraph (c)(3)(ii) or
(iii) of this section. See Sec. 1.14115(f)(2) for special effective
dates for the application of this paragraph (c)(3) to issues financing facilities subject to requirements contracts.
(ii) Requirements contract similar to take contract or take or pay
contract. A requirements contract generally meets the benefits and
burdens test to the extent that it contains contractual terms that
obligate the purchaser to make payments that are not contingent on the
output requirements of the purchaser or that obligate the purchaser to
have output requirements. For example, a requirements contract with an
industrial purchaser meets the benefits and burdens test if the
purchaser enters into additional contractual obligations with the
issuer or another governmental unit not to cease operations. A
requirements contract does not meet the benefits and burdens test,
however, by reason of a provision that requires the purchaser to pay
reasonable and customary damages (including liquidated damages) in the
event of a default, or a provision that permits the purchaser to pay a
specified amount to terminate the contract while the purchaser has
requirements, in each case if the amount of the payment is reasonably
related to the purchaser's obligation to buy requirements that is discharged by the payment.
(iii) Wholesale requirements contract(A) In general. A
requirements contract that is a sale at wholesale (a wholesale
requirements contract) may satisfy the benefits and burdens test, depending on all the facts and circumstances.
(B) Significant factors. Significant factors that tend to establish
that a wholesale requirements contract meets the benefits and burdens test include, but are not limited to
(1) The term of the contract is substantial relative to the term of the issue or issues that finance the facility; and
(2) The amount of output to be purchased under the contract
represents a substantial portion of the available output of the facility.
(C) Safe harbors. A wholesale requirements contract does not meet the benefits and burdens test if
(1) The term of the contract, including all renewal options, does
not exceed the lesser of 5 years or 30 percent of the term of the issue; or
(2) The amount of output to be purchased under the contract (and
any other requirements contract with the same purchaser or a related
party with respect to the facility) does not exceed 5 percent of the available output of the facility.
(iv) Retail requirements contract. Except as otherwise provided in
this paragraph (c)(3), a requirements contract that is not a sale at wholesale does not meet the benefits and burdens test.
(4) Output contract properly characterized as a lease.
Notwithstanding any other provision of this section, an output contract
that is properly characterized as a lease for Federal income tax
purposes shall be tested under the rules contained in Sec. Sec. 1.141
3 and 1.1414 to determine whether it is taken into account under the private business tests.
(d) Measurement of private business use. If an output contract
results in private business use under this section, the amount of
private business use generally is the amount of output purchased under the contract.
(e) Measurement of private security or payment. The measurement of
payments made or to be made by nongovernmental persons under output contracts as a percent of the debt service
[[Page 59761]]
of an issue is determined under the rules provided in Sec. 1.1414.
(f) Exceptions for certain contracts(1) Small purchases of
output. An output contract for the use of a facility is not taken into
account under the private business tests if the average annual payments
to be made under the contract do not exceed 1 percent of the average
annual debt service on all outstanding taxexempt bonds issued to
finance the facility, determined as of the effective date of the contract.
(2) Swapping and pooling arrangements. An agreement that provides
for swapping or pooling of output by one or more governmental persons
and one or more nongovernmental persons does not result in private
business use of the output facility owned by the governmental person to the extent that
(i) The swapped output is reasonably expected to be approximately
equal in value (determined over periods of three years or less); and
(ii) The purpose of the agreement is to enable each of the parties
to satisfy different peak load demands, to accommodate temporary
outages, to diversify supply, or to enhance reliability in accordance with prudent reliability standards.
(3) Shortterm output contracts. An output contract with a
nongovernmental person is not taken into account under the private business tests if
(i) The term of the contract, including all renewal options, is not longer than 3 years;
(ii) The contract either is a negotiated, arm'slength arrangement
that provides for compensation at fair market value, or is based on generally applicable and uniformly applied rates; and
(iii) The output facility is not financed for a principal purpose
of providing that facility for use by that nongovernmental person.
(4) Certain conduit parties disregarded. A nongovernmental person
acting solely as a conduit for the exchange of output among
governmentally owned and operated utilities is disregarded in
determining whether the private business tests are met with respect to financed facilities owned by a governmental person.
(g) Special rules for electric output facilities used to provide open access(1) Operation of transmission facilities by
nongovernmental persons(i) In general. The operation of an electric
transmission facility by a nongovernmental person may result in private
business use of the facility under Sec. 1.1413 and this section based
on all the facts and circumstances. For example, a transmission
facility is generally used for a private business use if a
nongovernmental person enters into a contract to operate the facility
and receives compensation based, in whole or in part, on a share of net profits from the operation of the facility.
(ii) Certain use by independent transmission operators. A contract
for the operation of an electric transmission facility by an
independent entity, such as a regional transmission organization or an
independent system operator (independent transmission operator), does not constitute private business use of the facility if
(A) The facility is owned by a governmental person;
(B) The operation of the facility by the independent transmission
operator is approved by the FERC under one or more provisions of the
Federal Power Act (16 U.S.C. 791a through 821c) (or by a state authority under comparable provisions of state law);
(C) No portion of the compensation of the independent transmission
operator is based on a share of net profits from the operation of the facility; and
(D) The independent transmission operator does not bear risk of loss of the facility.
(2) Certain use by nongovernmental persons under output contracts
(i) Transmission facilities. The use of an electric transmission
facility by a nongovernmental person pursuant to an output contract
does not constitute private business use of the facility if (A) The facility is owned by a governmental person;
(B) The facility is operated by an independent transmission
operator in a manner that satisfies paragraph (g)(1)(ii) of this section; and
(C) The facility is not financed for a principal purpose of
providing that facility for use by that nongovernmental person.
(ii) Distribution facilities. The use of an electric distribution
facility by a nongovernmental person pursuant to an output contract
does not constitute private business use of the facility if (A) The facility is owned by a governmental person;
(B) The facility is available for use on a nondiscriminatory, open
access basis by buyers and sellers of electricity in accordance with
rates that are generally applicable and uniformly applied within the meaning of Sec. 1.1413(c)(2); and
(C) The facility is not financed for a principal purpose of
providing that facility for use by that nongovernmental person (other than a retail enduser).
(3) Ancillary services. The use of an electric output facility to
provide ancillary services required to be offered as part of an open
access transmission tariff under rules promulgated by the FERC under
the Federal Power Act (16 U.S.C. 791a through 821c) does not result in private business use.
(4) Exceptions to deliberate action rules(i) Mandated wheeling.
Entering into a contract for the use of electric transmission or
distribution facilities is not treated as a deliberate action under Sec. 1.1412(d) if
(A) The contract is entered into in response to (or in anticipation
of) an order by the United States under sections 211 and 212 of the
Federal Power Act (16 U.S.C. 824j and 824k) (or a state regulatory authority under comparable provisions of state law); and
(B) The terms of the contract are bona fide and arm'slength, and
the consideration paid is consistent with the provisions of section 212(a) of the Federal Power Act.
(ii) Actions taken to implement nondiscriminatory, open access. An
action is not treated as a deliberate action under Sec. 1.1412(d) if
it is taken to implement the offering of nondiscriminatory, open
access tariffs for the use of electric transmission or distribution
facilities in a manner consistent with rules promulgated by the FERC
under sections 205 and 206 of the Federal Power Act (16 U.S.C. 824d and
824e) (or comparable provisions of state law). This paragraph
(g)(4)(ii) does not apply, however, to the sale, exchange, or other
disposition (within the meaning of section 1001(a)) of transmission or distribution facilities to a nongovernmental person.
(iii) Application of reasonable expectations test to certain
current refunding bonds. An action taken or to be taken with respect to
electric transmission or distribution facilities refinanced by an issue
is not taken into account under the reasonable expectations test of Sec. 1.1412(d) if
(A) The action is described in paragraph (g)(4)(i) or (ii) of this section;
(B) The bonds of the issue are current refunding bonds that refund bonds originally issued before February 23, 1998; and
(C) The weighted average maturity of the refunding bonds is not
greater than the remaining weighted average maturity of the prior bonds.
(5) Additional transactions as permitted by the Commissioner. The
Commissioner may, by published guidance, set forth additional
circumstances in which the use of electric output facilities in a
restructured electric industry does not constitute private business use.
[[Page 59762]]
(h) Allocations of output facilities and systems(1) Facts and
circumstances analysis. Whether output sold under an output contract is
allocated to a particular facility (for example, a generating unit), to
the entire system of the seller of that output (net of any uses of that
system output allocated to a particular facility), or to a portion of a
facility is based on all the facts and circumstances. Significant
factors to be considered in determining the allocation of an output contract to financed property are the following:
(i) The extent to which it is physically possible to deliver output to or from a particular facility or system.
(ii) The terms of a contract relating to the delivery of output
(such as delivery limitations and options or obligations to deliver power from additional sources).
(iii) Whether a contract is entered into as part of a common plan of financing for a facility.
(iv) The method of pricing output under the contract, such as the
use of market rates rather than rates designed to pay debt service of taxexempt bonds used to finance a particular facility.
(2) Illustrations. The following illustrate the factors set forth in paragraph (h)(1) of this section:
(i) Physical possibility. Output from a generating unit that is fed
directly into a low voltage distribution system of the owner of that
unit and that cannot physically leave that distribution system
generally must be allocated to those receiving electricity through that
distribution system. Output may be allocated without regard to physical
limitations, however, if exchange or similar agreements provide output
to a purchaser where, but for the exchange agreements, it would not be
possible for the seller to provide output to that purchaser.
(ii) Contract terms relating to performance. A contract to provide
a specified amount of electricity from a system, but only when at least
that amount of electricity is being generated by a particular unit, is
allocated to that unit. For example, a contract to buy 20 MW of system
power with a right to take up to 40 percent of the actual output of a
specific 50 MW facility whenever total system output is insufficient to
meet all of the seller's obligations generally is allocated to the specific facility rather than to the system.
(iii) Common plan of financing. A contract entered into as part of
a common plan of financing for a facility generally is allocated to the
facility if debt service for the issue of bonds is reasonably expected
to be paid, directly or indirectly, from payments under the contract.
(iv) Pricing method. Pricing based on the capital and generating
costs of a particular turbine tends to indicate that output under the contract is properly allocated to that turbine.
(3) Transmission and distribution contracts. Whether use under an
output contract for transmission or distribution is allocated to a
particular facility or to a transmission or distribution network is
based on all the facts and circumstances, in a manner similar to
paragraphs (h)(1) and (2) of this section. In general, the method used
to determine payments under a contract is a more significant contract
term for this purpose than nominal contract path. In general, if
reasonable and consistently applied, the determination of use of
transmission or distribution facilities under an output contract may be
based on a method used by third parties, such as reliability councils.
(4) Allocation of payments. Payments for output provided by an
output facility financed with two or more sources of funding are generally allocated under the rules in Sec. 1.1414(c).
(i) Examples. The following examples illustrate the application of this section:
Example 1. Joint ownership. Z, an investorowned electric utility, and City H agree to construct an electric generating facility of a size sufficient to take advantage of the economies of scale. H will issue $50 million of its 24year bonds, and Z will use $100 million of its funds for construction of a facility they will jointly own as tenants in common. Each of the participants will share in the ownership, output, and operating expenses of the facility in proportion to its contribution to the cost of the facility, that is, onethird by H and twothirds by Z. H's bonds will be secured by H's ownership interest in the facility and by revenues to be derived from its share of the annual output of the facility. H will need only 50 percent of its share of the annual output of the facility during the first 20 years of operations. It agrees to sell 10 percent of its share of the annual output to Z for a period of 20 years pursuant to a contract under which Z agrees to take that power if available. The facility will begin operation, and Z will begin to receive power, 4 years after the H bonds are issued. The measurement period for the property financed by the issue is 20 years. H also will sell the remaining 40 percent of its share of the annual output to numerous other private utilities under contracts of three years or less that satisfy the exception under paragraph (f)(3) of this section. No other contracts will be executed obligating any person to purchase any specified amount of the power for any specified period of time. No person (other than Z) will make payments that will result in a transfer of the burdens of paying debt service on bonds used directly or indirectly to provide H's share of the facilities. The bonds are not private activity bonds, because H's onethird interest in the facility is not treated as used by the other owners of the facility. Although 10 percent of H's share of the annual output of the facility will be used in the trade or business of Z, a nongovernmental person, under this section, that portion constitutes not more than 10 percent of the available output of H's ownership interest in the facility.
Example 2. Wholesale requirements contract. (i) City J issues
20year bonds to acquire an electric generating facility having a
reasonably expected economic life substantially greater than 20
years and a nameplate capacity of 100 MW. The available output of
the facility under paragraph (b)(1) of this section is approximately
17,520,000 MWh (100 MW x 24 hours x 365 days x 20 years). On the
issue date, J enters into a contract with T, an investorowned
utility, to provide T with all of its power requirements for a
period of 10 years, commencing on the issue date. J reasonably
expects that T will actually purchase an average of 30 MW over the
10year period. The contract is taken into account under the private
business tests pursuant to paragraph (c)(3) of this section because
the term of the contract is substantial relative to the term of the
issue and the amount of output to be purchased is a substantial portion of the available output.
(ii) Under paragraph (d) of this section, the amount of
reasonably expected private business use under this contract is
approximately 15 percent (30 MW x 24 hours x 365 days x 10 years, or
2,628,000 MWh) of the available output. Accordingly, the issue meets
the private business use test. J reasonably expects that the amount
to be paid for an average of 30 MW of power (less the operation and
maintenance costs directly attributable to generating that 30 MW of
power), will be more than 10 percent of debt service on the issue on
a presentvalue basis. Accordingly, the issue meets the private
security or payment test because J reasonably expects that payment
of more than 10 percent of the debt service will be indirectly
derived from payments by T. The bonds are private activity bonds
under paragraph (c) of this section. Further, if 15 percent of the
sale proceeds of the issue is greater than $15 million and the issue
meets the private security or payment test with respect to the $15
million output limitation, the bonds are also private activity bonds under section 141(b)(4). See Sec. 1.1418.
Example 3. Retail contracts. (i) State Agency M, a political
subdivision, issues bonds in 2003 to finance the construction of a
generating facility that will be used to furnish electricity to M's
retail customers. In 2007, M enters into a 10year contract with
industrial corporation I. Under the contract, M agrees to supply I
with all of its power requirements during the contract term, and I
agrees to pay for that power at a negotiated price as it is
delivered. The contract does not require I to pay for any power
except to the extent I has requirements. In addition, the contract
requires I to pay reasonable and customary liquidated damages in the
event of a default by I, and permits I to terminate the contract
while it has requirements by paying M a specified amount that is a
reasonable and customary amount for terminating the contract. Any
damages or termination payment by I will be reasonably related to I's
[[Page 59763]]
obligation to buy requirements that is discharged by the payment.
Under paragraph (c)(3) of this section, the contract does not meet
the benefits and burdens test. Thus, it is not taken into account under the private business tests.
(ii) The facts are the same as in paragraph (i) of this Example
3, except that the contract requires I to make guaranteed minimum
payments, regardless of I's requirements, in an amount such that the
contract does not meet the exception for small purchases in
paragraph (f)(1) of this section. Under paragraph (c)(3)(ii) of this
section, the contract meets the benefits and burdens test because it
obligates I to make payments that are not contingent on its output
requirements. Thus, it is taken into account under the private business tests.
Example 4. Allocation of existing contracts to new facilities. Power Authority K, a political subdivision created by the
legislature in State X to own and operate certain power generating
facilities, sells all of the power from its existing facilities to
four private utility systems under contracts executed in 1999, under
which the four systems are required to take or pay for specified
portions of the total power output until the year 2029. Existing
facilities supply all of the present needs of the four utility
systems, but their future power requirements are expected to
increase substantially beyond the capacity of K's current generating
system. K issues 20year bonds in 2004 to construct a large
generating facility. As part of the financing plan for the bonds, a
fifth private utility system contracts with K to take or pay for 15
percent of the available output of the new facility. The balance of
the output of the new facility will be available for sale as
required, but initially it is not anticipated that there will be any
need for that power. The revenues from the contract with the fifth
private utility system will be sufficient to pay less than 10
percent of the debt service on the bonds (determined on a present
value basis). The balance, which will exceed 10 percent of the debt
service on the bonds, will be paid from revenues derived from the
contracts with the four systems initially from sale of power
produced by the old facilities. The output contracts with all the
private utilities are allocated to K's entire generating system. See
paragraphs (h)(1) and (2) of this section. Thus, the bonds meet the
private business use test because more than 10 percent of the
proceeds will be used in the trade or business of a nongovernmental
person. In addition, the bonds meet the private security or payment
test because payment of more than 10 percent of the debt service,
pursuant to underlying arrangements, will be derived from payments in respect of property used for a private business use.
Example 5. Allocation to displaced resource. Municipal utility MU, a political subdivision, purchases all of the electricity required to meet the needs of its customers (1,000 MW) from B, an investorowned utility that operates its own electric generating facilities, under a 50year take or pay contract. MU does not anticipate that it will require additional electric resources, and any new resources would produce electricity at a higher cost to MU than its cost under its contract with B. Nevertheless, B encourages MU to construct a new generating plant sufficient to meet MU's requirements. MU issues obligations to construct facilities that will produce 1,000 MW of electricity. MU, B, and I, another investorowned utility, enter into an agreement under which MU assigns to I its rights under MU's take or pay contract with B. Under this arrangement, I will pay MU, and MU will continue to pay B, for the 1,000 MW. I's payments to MU will at least equal the amounts required to pay debt service on MU's bonds. In addition, under paragraph (h)(1)(iii) of this section, the contract among MU, B, and I is entered into as part of a common plan of financing of the MU facilities. Under all the facts and circumstances, MU's assignment to I of its rights under the original take or pay contract is allocable to MU's new facilities under paragraph (h) of this section. Because I is a nongovernmental person, MU's bonds are private activity bonds.
Example 6. Operation of transmission facilities by regional
transmission organization. (i) Public Power Agency D is a political
subdivision that owns and operates electric generation, transmission
and distribution facilities. In 2003, D transfers operating control
of its transmission system to a regional transmission organization
(RTO), a nongovernmental person, pursuant to an operating agreement
that is approved by the FERC under sections 205 and 206 of the
Federal Power Act. D retains ownership of its facilities. No portion
of the RTO's compensation is based on a share of net profits from
the operation of D's facilities, and the RTO does not bear any risk
of loss of those facilities. Under paragraph (g)(1)(ii) of this
section, the RTO's use of D's facilities does not constitute a private business use.
(ii) Company A is located in D's service territory. In 2004,
Power Supplier E, a nongovernmental person, enters into a 10year
contract with A to supply A's electricity requirements. The
electricity supplied by E to A will be transmitted over D's
transmission and distribution facilities. D's distribution
facilities are available for use on a nondiscriminatory, open access
basis by buyers and sellers of electricity in accordance with rates
that are generally applicable and uniformly applied within the
meaning of Sec. 1.1413(c)(2). D's facilities are not financed for
a principal purpose of providing the facilities for use by E. Under
paragraph (g)(2) of this section, the contract between A and E does not result in private business use of D's facilities.
Example 7. Certain actions not treated as deliberate actions. The facts are the same as in Example 6 of this paragraph (i), except that the RTO's compensation is based on a share of net profits from operating D's facilities. In addition, D had issued bonds in 1994 to finance improvements to its transmission system. At the time D transfers operating control of its transmission system to the RTO, D chooses to apply the private activity bond regulations of Sec. Sec. 1.1411 through 1.14115 to the 1994 bonds. The operation of D's facilities by the RTO results in private business use under Sec. 1.1413 and paragraph (g)(1)(i) of this section. Under the special exception in paragraph (g)(4)(ii) of this section, however, the transfer of control is not treated as a deliberate action. Accordingly, the transfer of control does not cause the 1994 bonds to meet the private activity bond tests.
Example 8. Current refunding. The facts are the same as in
Example 7 of this paragraph (i), and in addition D issues bonds in
2004 to currently refund the 1994 bonds. The weighted average
maturity of the 2004 bonds is not greater than the remaining
weighted average maturity of the 1994 bonds. D chooses to apply the
private activity bond regulations of Sec. Sec. 1.1411 through
1.14115 to the refunding bonds. In general, reasonable expectations
must be separately tested on the date that refunding bonds are
issued under Sec. 1.1412(d). Under the special exception in
paragraph (g)(4)(iii) of this section, however, the transfer of the
financed facilities to the RTO need not be taken into account in
applying the reasonable expectations test to the refunding bonds. Sec. 1.1417T [Removed]
Par. 5. Section 1.1417T is removed.
Par. 6. Section 1.1418 is added to read as follows:
Sec. 1.1418 $15 million limitation for output facilities.
(a) In general(1) General rule. Section 141(b)(4) provides a
special private activity bond limitation (the $15 million output
limitation) for issues 5 percent or more of the proceeds of which are
to be used to finance output facilities (other than a facility for the
furnishing of water). Under this rule, an issue consists of private
activity bonds under the private business tests of section 141(b)(1)
and (2) if the nonqualified amount with respect to output facilities
financed by the proceeds of the issue exceeds $15 million. The $15
million output limitation applies in addition to the private business
tests of section 141(b)(1) and (2). Under section 141(b)(4) and
paragraph (a)(2) of this section, the $15 million output limitation is
reduced in certain cases. Specifically, an issue meets the test in section 141(b)(4) if both of the following tests are met:
(i) More than $15 million of the proceeds of the issue to be used
with respect to an output facility are to be used for a private
business use. Investment proceeds are disregarded for this purpose if
they are not allocated disproportionately to the private business use portion of the issue.
(ii) The payment of the principal of, or the interest on, more than
$15 million of the sale proceeds of the portion of the issue used with
respect to an output facility is (under the terms of the issue or any underlying arrangement) directly or indirectly
[[Page 59764]]
(A) Secured by any interest in an output facility used or to be
used for a private business use (or payments in respect of such an output facility); or
(B) To be derived from payments (whether or not to the issuer) in
respect of an output facility used or to be used for a private business use.
(2) Reduction in $15 million output limitation for outstanding
issues(i) General rule. In determining whether an issue 5 percent or
more of the proceeds of which are to be used with respect to an output
facility consists of private activity bonds under the $15 million
output limitation, the $15 million limitation on private business use
and private security or payments is applied by taking into account the
aggregate nonqualified amounts of any outstanding bonds of other issues
5 percent or more of the proceeds of which are or will be used with
respect to that output facility or any other output facility that is part of the same project.
(ii) Bonds taken into account. For purposes of this paragraph
(a)(2), in applying the $15 million output limitation to an issue (the
later issue), a taxexempt bond of another issue (the earlier issue) is taken into account if
(A) That bond is outstanding on the issue date of the later issue;
(B) That bond will not be redeemed within 90 days of the issue date
of the later issue in connection with the refunding of that bond by the later issue; and
(C) 5 percent or more of the sale proceeds of the earlier issue
financed an output facility that is part of the same project as the
output facility that is financed by 5 percent or more of the sale proceeds of the later issue.
(3) Benefits and burdens test applicable(i) In general. In
applying the $15 million output limitation, the benefits and burdens
test of Sec. 1.1417 applies, except that ``$15 million'' is applied
in place of ``10 percent'', or ``5 percent'' as appropriate.
(ii) Earlier issues for the project. If bonds of an earlier issue
are outstanding and must be taken into account under paragraph (a)(2)
of this section, the nonqualified amount for that earlier issue is
multiplied by a fraction, the numerator of which is the adjusted issue
price of the earlier issue as of the issue date of the later issue, and
the denominator of which is the issue price of the earlier issue. Pre
issuance accrued interest as defined in Sec. 1.1481(b) is disregarded for this purpose.
(b) Definition of project(1) General rule. For purposes of
paragraph (a)(2) of this section, project has the meaning provided in
this paragraph. Facilities that are functionally related and
subordinate to a project are treated as part of that same project.
Facilities having different purposes or serving different customer
bases are not ordinarily part of the same project. For example, the following are generally not part of the same project
(i) Generation, transmission and distribution facilities;
(ii) Separate facilities designed to serve wholesale customers and retail customers; and
(iii) A peaking unit and a baseload unit (regardless of the location of the units).
(2) Separate ownership. Except as otherwise provided in this
paragraph (b)(2), facilities that are not owned by the same person are
not part of the same project. If different governmental persons act in
concert to finance a project, however (for example as participants in a
joint powers authority), their interests are aggregated with respect to
that project to determine whether the $15 million output limitation is
met. In the case of undivided ownership interests in a single output
facility, property that is not owned by different persons is treated as
separate projects only if the separate interests are financed (i) With bonds of different issuers; and
(ii) Without a principal purpose of avoiding the limitation in this section.
(3) Generating property(i) Property on same site. In the case of
generation and related facilities, project means property located at the same site.
(ii) Special rule for generating units. Separate generating units
are not part of the same project if one unit is reasonably expected, on
the issue date of each issue that finances the units, to be placed in
service more than 3 years before the other. Common facilities or
property that will be functionally related to more than one generating
unit must be allocated on a reasonable basis. If a generating unit
already is constructed or is under construction (the first unit) and
bonds are to be issued to finance an additional generating unit (the
second unit), all costs for any common facilities paid or incurred
before the earlier of the issue date of bonds to finance the second
unit or the commencement of construction of the second unit are
allocated to the first unit. At the time that bonds are issued to
finance the second unit (or, if earlier, upon commenc
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