The Internal Revenue Service has ruled that a state conservation and reclamation district can issue tax-exempt bonds to finance the acquisition of a private power plant because its public wholesale customers can be included in its "qualified service area," a geographic designation that dictates when bond proceeds can be used to acquire private entities.

The private-letter ruling, which was dated May 8 but not publicly released until this week, stated that the district could use tax-exempt bond proceeds to pay for the acquisition of an investor-owned power plant that would in turn provide power to the district's wholesale customers, which are also governmental entities.

The issuer, state, customers, and plant were not identified in the ruling.

Private-letter rulings are supposed to be applicable only to the issuers who request them and their particular facts and circumstances, and the IRS explicitly states that they cannot be cited or used as precedent in other tax matters. Nevertheless, they are believed to provide insights into the IRS' thinking, particularly on tax matters where little guidance exists or market participants have questions.

Bond lawyers said this week that the ruling could prove helpful to issuers in similar circumstances, specific though they may be.

Thomas Vander Molen, a partner at Dorsey & Whitney LLP in Minneapolis, said yesterday that the IRS could have taken a more narrow approach, permitting the issuer to only use bond proceeds to buy private equipment that would have benefited its retail customers. Instead the agency said using bonds to buy private equipment to provide power to wholesale customers is permitted as well.

"I think it will be helpful in that narrow universe to open up some options," Vander Molen said.

According to the ruling, the district generates and sells electricity directly to municipalities, an electric cooperative and "large industrial and commercial customers." In addition, the district sells power to a group of wholesale customers consisting of governmental units and a joint action agency. Those wholesalers in turn sell that electricity to their own customers at the retail level.

The district wanted to increase its generating capacity, and so it entered into an agreement with an investor-owned utility under which the utility would buy out ownership interests in a power plant and in turn sell all of the plant assets to the district. The district plans to issue bonds to finance a portion of the acquisition costs, but the private-letter ruling does not specify the amount.

The tax code stipulates that tax-exempt bond proceeds cannot be used to buy out investor-owned utilities. But it contains an exception under which bonds can be used for such a purchase if the property is to be used in an existing qualified-service area of the governmental entity that it has been providing service to for at least 10 years.

The statute does not make a distinction between retail and wholesale customers. Under this exception, the plant does not have to be physically located within a service area, but the electricity it produces must be sold there.

The district told the IRS that it will have provided electricity to the wholesale customers for at least 10 years when the plant is scheduled to be purchased. The governmental wholesale customers in turn will have provided electricity across their geographic borders to retail customers for at least 10 years when the plant is purchased.

All joint action agency members have been providing power for at least 10 years, but one member has not been part of the agency for that long. As a result, the district told the IRS it would not treat the area the most recent member serves as part of the qualified service area with regard to the bonds.

The IRS determined in its ruling that the governmental wholesalers and all but the most recent member of the joint action agency will be part of the qualified service area.

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