A private management contract for a bond-financed solid-waste disposal facility that would not meet tax law requirements in special circumstances like hurricanes would not constitute private use and jeopardize the tax-exempt status of the bonds, the Internal Revenue Service said in a recent ruling.
The IRS detailed its ruling on the facility in a private-letter ruling that was publicly released last Monday. The ruling, dated Dec. 11, did not identify the bonds or the issuer. Private-letter rulings, while technically applicable only to the issuer that requested them, are seen as important guidance on the IRS' thinking on tax matters.
"The principle here, that you can go outside of the management contract rules if the volume of the solid waste you have to treat is something outside of your control, could apply to virtually any type of contract where the manager has costs that are associated with volume," said David Caprera, a partner at Kutak Rock LLP in Denver.
But Caprera and other lawyers said they would be reluctant to apply this ruling to other situations because it seemed to turn on the need to be flexible in special situations such as a hurricane or excessive rainfall.
In the ruling, the IRS determined that a private management contract for a solid waste disposal facility did not constitute private business use despite the fact that it failed to meet regulations established by the agency on management contracts.
The contract was structured in such a way that the manager was paid both, a base fee for processing a minimum amount of tons of waste annually, and also a varying "per-unit" fee that was determined by the tons of waste processed beyond that minimum.
Under tax rules, no more than 20 percent of income can be tied to performance. Typically, if performance-based payments exceed 20 percent, it would be considered private business use. The rules also say that bonds would be private activity bonds and possibly taxable if more than 10 percent of the proceeds are used by private parties and more than 10 percent of the payments are private.
Typically, the management contract for the solid waste disposal facility adhered to those rules, with a 20 percent cap placed on the per-unit fee. However, in cases of "excessive rainfall," where rainfall exceeds a predetermined amount in a month, or in a force majeure situation, where a state of emergency is declared for a major storm or hurricane, the cap is removed, because the facility can expect to process a significant increase in tons of waste in the aftermath. The rainfall makes the waste heavier.
The IRS determined that the contract would not constitute private business use, because the 20 percent cap only would be removed because of weather conditions beyond anyone's control.
"The per-unit fees paid pursuant to the excessive rainfall exception and the force majeure exception represent payment for processing additional tons of solid waste generated as a result of events that are beyond the control of either the manager or the county," the ruling stated.
Caprera said that one could potentially read the ruling as permitting similar contract exceptions. However, he added that he would be reluctant to take that view at this point.
"Is that overreading that ruling? I think it is," he said.
Since the publicly-released ruling contains no detailed information about the facility, Caprera maintains it is not enough to provide a basis for guidance. Since the ruling mentions hurricanes, it is possible that the ruling pertains to a facility dealing with the aftermath of Hurricane Katrina. The IRS has made special exceptions that cannot be extended to the rest of the country, he said.
"It's clear that the IRS has issued favorable rulings in unusual circumstances," Caprera said.
Charles Henck, an attorney with Ballard Spahr Andrews & Ingersoll LLP here, agreed with Caprera that he would be reluctant to offer guidance strictly from the ruling.
"What other thing is going to happen that's like having a hurricane?" Henck said. However, he added that it is encouraging to see the IRS willing to consider exceptions for certain situations.
IRS officials declined to elaborate on the ruling.