An electric and gas utility can demolish tax-exempt bond-financed pollution control facilities that are no longer in compliance with environmental standards without jeopardizing the tax status of the bonds, the Internal Revenue Service concluded in a recent private-letter ruling.

"Demolition ... precludes any further use of the project facilities by causing them to change from what is currently an unexpected, non-functional use to no use at all except potentially as scrap materials for recycling," the IRS stated in the ruling, which was dated April 7 but not publicly released until yesterday. "This is not a change of use within the meaning of" the tax code, the agency said.

The IRS also found that the utility could continue to deduct interest from the loan agreements that were entered into in connection with the bonds.

Bond lawyers said they are not surprised at the ruling, which does not identify the parties involved or the bonds.

"I can understand why they requested it, but I would have been shocked if they hadn't gotten it," said Frederic Ballard Jr., a partner at Ballard, Spahr, Andrews & Ingersoll LLP here. "It's been very widely assumed by professionals that if you take bond facilities out of service, that is not a requirement for bond redemption."

The ruling stems from bonds that were issued by a public benefit corporation with a mission to development new energy and conservation technologies. The bonds were used to refund previously issued debt.

The proceeds of the original bonds were lent to an electric and gas utility to finance the construction of pollution control facilities that were needed to comply with federal and state air-quality standards and water permits.

The bonds were exempt-facility private-activity bonds and were issued after the Tax Reform Act of 1986 took effect. But they were grandfathered from provisions in the act that prohibited pollution control facilities from being financed with tax-exempt private-activity bonds.

After the bonds were issued to refund the initial debt, the power plant and pollution control facilities were sold to another privately owned utility. But the state charged that the pollution control facilities were not in compliance with federal and state environmental laws.

The utility eventually entered into a consent decree with the state to settle the charges. The consent decree required the facilities to be upgraded or converted.

But the utility decided it would not be cost-effective to make the upgrades or conversions and decided the best course would be to demolish the facilities and recycle the scrap materials.

Under change-of-use rules that apply to most private-activity bonds and a preexisting revenue procedure that was withdrawn after those rules were issued, if the use of a bond-financed facility changes so that it no longer serves a purpose that qualifies for tax-exemption, the bonds become taxable. In some change-of-use cases, the IRS has permitted bonds to remain tax-exempt if they are redeemed.

But in this case, the agency said the use of the facilities would not be changing because the facilities would no longer exist. The IRS stressed that the private-letter ruling is only directed to the taxpayer that requested it and "may not be used or cited as precedent."

Nevertheless, bond lawyers are often interested in private-letter rulings for guidance, particularly if there are no other rules or guidance pertaining to the tax question being analyzed in the ruling.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.