IRS letter ruling is positive, but raises questions
WASHINGTON -- The Internal Revenue Service has issued a private letter ruling that concludes a city transportation authority's commuter rail division qualifies is a political subdivision that can issue tax-exempt bonds.
Several lawyers said the ruling is positive, some questioned why it was sought, and a couple were concerned about the IRS's reference to a 40-year old revenue ruling.
Private letter ruling, PLR-139748-16, was publicly released earlier this month and does not identify the parties involved.
The IRS said in the PLR that the division is controlled by the state, the transportation authority and all of the metro area county and city governments. It is charged under state law with providing public transportation by commuter rail within the authority's jurisdiction. The agency also said the division's board members are appointed by the governing bodies of the counties and city comprising the metro area and may be removed by the governor or the state for cause.
The division "possesses the power to pass rules and regulations proper and necessary to regulate the use, operation and maintenance of its property and facilities that have [an] effect on the public within its jurisdiction" and "may also impose fines and penalties for violations of those rules and regulations," the IRS said. The division, "is authorized to provide, through [a] corporation, a police force to protect persons and property and enforce rules and regulations related to [the] commuter rail," it said.
“The police force has the same powers with regard to protection of persons and property as those exercised by municipal police,” the IRS said, adding, "We conclude that [the] division possesses substantial police power."
"Based on these facts, we conclude the division is a division of a state or local government for purposes of Section 1.103-1(b)" of the federal tax code, the IRS said. This section of the tax code deals with which entities can issue tax-exempt bonds.
Richard Chirls, a partner at Orrick, Herrington & Sutcliffe in New York City, who was not involved in the PLR, said it seemed to him “very clear that the entity qualifies as a political subdivision.”
Chirls said “a positive element’’ of the PLR is “that it confirms established law that the police power includes the ability to implement rules and regulations to regulate use, operation and maintenance of property. Thus a police force is not the only way to establish police powers.’’
J. Hobson Presley Jr., a partner at Balch and Bingham in Birmingham, Ala., said, “It’s possible the people who asked for this ruling did it out of an abundance of caution.’’ He said the “ruling reached the right conclusion,’’ but added, “it’s always difficult to glean all the facts’’ from a PLR.
But Chirls, who has argued with the IRS over the definition of a political subdivision in its audit of community development districts in Florida, said, “This request for a ruling may reflect the great deal of uncertainty that the IRS and Treasury has created in the municipal community regarding what was once considered well-settled law.”
"Although this ruling comes to the clear correct conclusion, this ruling reflects that the IRS continues to bungle and mangle its analysis and treatment of the political subdivision issue," he said. "The ruling references an old revenue ruling for the proposition that the determination of political subdivision is based on taking into account all of the facts and circumstances, including the public purposes of the entity and its control by a government.' This has become part of the IRS's mantra on the definition of political subdivision. However, there is no authority for this statement, other than the IRS's own ruling."
In the law and analysis section of the letter ruling, the IRS referenced the 1944 appeals court ruling in Commissioner of Internal Revenue v. Shamberg's Estate, which the American Bar Association's Section of Taxation has described as the leading case interpreting the meaning of political subdivision. That case said that there are three elements of sovereign power -- the power of eminent domain, taxation and policing -- and required that part or a portion of them be present to conclude that an entity is a political subdivision for a governmental purpose under state law.
Subsequent authorities made it clear that a substantial amount of any one of these three sovereign powers must be present for an entity to be a political subdivision, the ABA Section of Taxation said in comments it sent the IRS and Treasury.
The PLR also referenced Revenue Ruling 77-164, saying, "Possession of only an insubstantial amount of any or all of the sovereign powers is not sufficient. All of the facts and circumstances must be taken into consideration, including the public purposes of the entity and its control by a government."
"In fact, the language of this new ruling is expressly inconsistent with the consideration of numerous unidentified facts and circumstances by directly quoting the existing Treasury regulation and the Shamberg case for the clear proposition that the sole determination of a political subdivision is based on the existence of sovereign powers," Chirls said.
Treasury and the IRS proposed rules on political subdivisions in February 2016 that said, in addition to having the ability to exercise a substantial amount of one of three sovereign powers described in Shamberg, they must also be governmentally controlled and serve a governmental purpose “with no more than an incidental private benefit.”
The National Association of Bond Lawyers Association and the ABA Section of Taxation, as well as many other muni market groups, have strongly opposed that proposed definition. The lawyers groups insist that the Shamberg ruling and related authorities should be the sole basis for defining a political subdivision that can issue tax-exempt bonds. They say this is well-settled law.
"NABL’s position on the definition of political subdivision hasn’t changed," said Cliff Gerber, president of NABL and a partner at Norton Rose Fulbright in San Francisco. "This does not mean ... that we ignore Revenue Ruling 77-164 entirely. As the private letter ruling notes, all of the facts and circumstances of a particular case must be taken into consideration. The public purposes of the entity and its control by a government are simply part of that concept."
But Gerber added, "Recognizing the limitations of Revenue Ruling 77-164, there is no actual precedent supporting control as an independent requirement for qualifying as a political subdivision."
Treasury sent President Trump recommendations on whether to modify or rescind the proposed rules on political subdivisions and seven sets of regulations on Monday, but did not publicly release the document or provide any comments on its content. The regulations were identified by Treasury under President Trump's Executive Order 13789.
That executive order asked Treasury to review significant tax regulations issued since Jan. 1, 2016 and identify those that: "impose an undue financial burden on United States taxpayers; add undue complexity to the Federal tax laws; or exceed the statutory authority of the Internal Revenue Service.'' Treasury was supposed to send its recommendations to Trump by Sept. 18 on whether to rescind or modify those rules.
Treasury Deputy Tax Legislative Counsel Krishna Vallabhaneni said over the weekend that the recommendations will be published in the Federal Register later this month.