WASHINGTON – Four port authorities and a wholesale electricity provider are warning that rules proposed by the Treasury Department and Internal Revenue Service earlier this year could hurt their standing as political subdivisions and their ability to issue bonds as well as complicate their governing structures.
The port authorities from Ohio and Oregon and the Municipal Energy Agency of Nebraska made their remarks in public comments on the proposed political subdivision rules submitted to the IRS and Treasury. Comments on the proposed rules are due Monday, and a public hearing will be held on June 6.
Under the current definition, an entity is a political subdivision that can issue tax-exempt bonds if it has a right to exercise a substantial amount of at least one of three recognized sovereign powers of a state or local governmental unit: eminent domain, taxation or police.
But federal regulators have worried the current definition has resulted in a number of developer-controlled boards that issues tax-exempt bonds for their own private benefit.
The new regulations, proposed in February by Treasury and IRS, add two new requirements – that political subdivisions serve a governmental purpose "with no more than an incidental private benefit" and be governmentally controlled.
To be governmentally controlled, a political subdivision would have to be controlled by a state or local governmental unit or an electorate. Chris Burnham, president of the Development Finance Authority in Summit County, Ohio, said it would be "significantly impacted" by the new definition.
According to its website, DFA has issued more than $835 million in economic development bonds since 1999.The DFA is an independent political subdivision of the state and not a component unit of any other government entity, Burnham said.
"We are very concerned with the newly-proposed IRS definition of political subdivisions for tax-exempt bond purposes," Burnham wrote in a May 18 letter to the IRS.
Burnham's first concern is that because the DFA is an independent political subdivision of Ohio, is not a component unit of any other government entity, and controls its own budget, it would not meet the governmental control test.
He is also concerned that the proposed rules would require that any private benefit from port authority operations would have to be "no more than incidental."
"Many Ohio port authorities provide financing that can be construed as private benefit – we issue tax-exempt revenue bonds for parking garages and other public infrastructure through tax increment financing, which under state law, does benefit a private development project," Burnham said.
"While the IRS may provide helpful clarity on the proposed governmental control test, it seems to us the public purpose test will be more challenging for Ohio port authorities like the DFA," he said.
Cleveland-Cuyahoga County Port Authority chief financial officer Brent Leslie said the proposed rules' governmental control standard might be "problematic" for entities with appointed boards, like the port authority. He also worried the rules would "overly politicize" the authority's nine-member board, whose members are appointed by local officials but cannot be removed at will. Other port authorities and special units/districts could run into the same problem, he added.
Leslie said the regulations have striking similarities to accounting regulations for component units, which mean an entity not a component unit of another government would have trouble meeting the government control test.
"I do not believe this is the intent of the regulations, but some additional clarity around the definition of control would make sure that ports, airports, and other special units/districts have the ability to continue to issue tax-exempt debt for the benefit of the citizens we represent," Leslie wrote.
Daniel Blaufus, general counsel for The Port of Portland, Ore., argued in a May 11 letter that two provisions in the proposed regulations could threaten the port's status as a political subdivision. First, the prohibition on "more than an incidental private benefit" could conflict with the port's ability to issue exempt facility bonds, he said. Second, the governmental control requirement "is inconsistent" with state statutes that give the power to remove port commissioners to a different governmental entity than the one that appoints them. The state statutes also limit the permissible rationale for removal to malfeasance.
The proposed rules require every political subdivision serve a "governmental purpose," but fail to define the term, he said. Under the rules, the determination of whether an entity serves a governmental purpose would be based on whether it carries out public purposes set forth its enabling legislation and whether it operates in a manner that provides a significant benefit "with no more than an incidental private benefit."
"The port is subject to a statutory governance structure like that of many port and airport districts throughout the country," Blaufus wrote in his three-page letter. "This governance structure would potentially conflict with the requirements set forth in the proposed regulations."
Robert Poehling, the executive director and chief executive officer of the Municipal Energy Agency of Nebraska that provides electric power to 66 communities in Nebraska, Iowa, Colorado and Wyoming, went a step further.
He said, "the IRS should withdraw these proposed rules and, if need be, propose a more targeted approach to address the abuses it is seeking to prevent with these proposed rules."
The MEAN agrees with the American Public Power Association's view that the proposed rules would "unnecessarily disturb [a] well-settled definition" and "will create unnecessary confusion and uncertainty," he said.
In April, the National Association of Bond Lawyers called on Treasury and the IRS to revise and re-propose the rules rather than revise and finalize them. Bond lawyers claimed they would trample states' rights, alter the landscape for public financing, and jeopardize the tax-exempt status of millions of dollars of municipal bonds.
Several lawyers also told Treasury and IRS officials at NABL's 14th Tax and Securities Law Institute in March that the proposed requirements were too broad, arbitrary and unnecessary.
Other entities that could suffer as a result of the proposed regulations, some lawyers argued, were public universities set up under state constitutions and have procedures for electing trustees, as well as political subdivisions that were initially temporarily controlled by developers who sold bonds to build infrastructure for future retirement, housing or other communities.
John Cross, Treasury's associate tax legislative counsel, said at the March conference that IRS audits had exposed a vulnerability of political subdivisions to be controlled by private entities. That vulnerability "raised concerns at the highest levels of government," he said, which contributed to the proposed regulations. Cross said that while states may have rules for creating political subdivisions, the federal government can regulate how tax-exempt bonds are issued because they involve a federal tax subsidy.