IRS Rules On Energy Debt Issue

WASHINGTON — A public power provider can issue tax-exempt bonds to finance a wind facility even if it sells renewable energy certificates to private parties, the Internal Revenue Service has ruled.

Selling the certificates to investor-owned electric utilities so they can comply with state requirements to obtain a certain percentage of power from ­renewable energy sources will not impact the use of the wind facility and therefore will not result in private business use, the IRS said in a private-letter ruling.

Bond attorneys were not surprised by the ruling, but were pleased to see the IRS side with the issuer.

“I think the holding of the ruling is correct, but it always is comforting when the IRS acknowledges limits to what constitutes indirect private use, as it has done so here,” said Thomas Vander Molen, a partner at Dorsey & Whitney LLP.

The IRS did not identify the wind facility or any of the parties in the PLR, which was dated June 14 but not published until this week. Rather, it simply said the facility was owned by a “public instrumentality” in an unnamed state charged with acquiring, constructing and operating electric generating facilities, as well as selling that power and issuing bonds.

According to the private-letter ruling, the public entity planned to issue three sets of bonds to acquire the partially constructed facility, complete its construction and equipping as well as refinance the initial bonds, and finance additional costs of the facility as well as refinance the second offering.

The issuer expected some of the output from the facility would be allocated for renewable energy certificates, which would then be sold to “nongovernmental persons.”

Such certificates are purchased by electric utilities that provide power in states that have adopted “renewable portfolio standards,” which require private utilities to demonstrate that a certain portion of their power is derived from renewable energy sources.

Utilities can meet that requirement by purchasing the certificates.

Currently, 24 states and the District of Columbia have adopted renewable portfolio standards, according to the U.S. Department of Energy. The IRS weighed in on a similar matter in a private-letter ruling issued in April 2009, finding that a governmental district that had a hydroelectric facility could sell such certificates to a private utility without causing private business use.

However, in that ruling, the private utility had no recourse if the issuer decided to shut down the hydro plant.

In this new ruling, the private utility has more leverage.

Under the contract the issuer would enter into with a private utility, the issuer would agree to provide a certain amount of certificates to the utility.

If the wind facility generated less than required by the certificate in any month, the issuer would provide more certificates the next month and the contract would be extended to address the shortfall.

If the wind facility failed to operate due to “force majeure” — an extraordinary event like a natural disaster beyond either party’s control — the private utility would be able to extend the contract for the same amount of time the facility was out of commission, or could terminate the contract and receive a payment from the issuer.

The contract also stipulates that if the issuer failed to deliver the requested number of certificates to a private utility because it sold certificates to another party, or because it abandoned or shut down the facility, it must pay the utility the difference between the purchase price of the certificates and the amount the utility has to pay to acquire certificates elsewhere.

Similarly, the utility has the right to terminate the contract if the issuer shuts down the facility and pays the utility.

The IRS determined that the sale of certificates does not affect the amount of power generated by the wind facility. It also found the contract between the issuer and the private utility would not entitle the utility to use the facility.

Private-letter rulings are supposed to be applicable only to the issuers that request them and to the particular facts and circumstances underlying the request. The IRS explicitly states that the rulings cannot be cited or used as precedent in other tax matters.

Nevertheless, market participants contend that the rulings provide insights into the agency’s thinking, particularly on tax matters where little guidance exists and questions have arisen.

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