WASHINGTON -- The final version of the Internal Revenue Service's sewage facility regulations includes some, but not all, of the liberalizations to the proposed rules that had been sought by the tax-exempt bond industry, lawyers said last week.
The sources said the most important change in the rules was the IRS' decision to expand the types of treatment that qualify a plant for tax-exempt financing to include tertiary and advanced treatment of wastewater. But despite the industry's urging, the service declined to also include pretreatment as an eligible function.
The regulations were scheduled for publication in the Dec. 23 Federal Register, and are effective for bonds issued 60 days after that date.
"By and large I think this rule is a good one," said William Loafman, a lawyer with Whitman, Breed, Abbott & Morgan in New York City.
The IRS has done "a pretty good job of distinguishing between those things that constitute a factory's pretreatment facility, and what normally would be a municipally owned system," said Loafman, though he added that the rules still place too many restrictions on municipal systems that use a private operator.
Overall, IRS officials "were pretty responsive. Generally speaking, they have addressed most of our concerns," said Robert Buck, a lawyer with Palmer & Dodge who spoke on behalf of the National Association of Bond Lawyers at a July hearing on the proposed sewage rules.
"This is an example of where the system worked," Buck said.
The IRS proposed the rules last May to clarify the conditions under which wastewater treatment plants that have some private involvement can be defined as sewage facilities eligible for tax-exempt, private-activity bond financing.
Such plants are distinguished from wastewater pollution control facilities, which were prohibited from using tax-exempt financing by the Tax Reform Act of 1986.
The proposed rules defined a sewage facility eligible for tax-exempt financing as one that provides primary or secondary treatment of wastewater having an average daily raw waste load concentration of biochemical oxygen demand, or BOD, that does not exceed 350 milligrams per liter as oxygen.
In response to comments, the final regulations state that plants providing advanced and tertiary treatment of wastewater are also included in the definition of a qualified sewage facility.
But the IRS failed to also add pretreatment, saying that it had "concluded that pretreatment property is more in the nature of water pollution property, which is ineligible for tax-exempt, private-activity bond financing."
In failing to bless pretreatment, however, the IRS did narrow the definition of what constitutes pretreatment, which some lawyers said is a helpful change.
Bond lawyers had also urged the IRS to eliminate the BOD limit, calling it arbitrary and saying it would penalize municipalities that choose to treat sewage at higher levels, particularly those engaging in water conservation efforts that can lead to higher BOD levels.
In the final rules the IRS declined to do away with the BOD standard entirely, but modified it so that it does not apply "if the failure to satisfy the limit results from the implementation of federal, state, or local water conservation measures."
In response to a number of questions, the service also clarified that the BOD level must be measured at the time the wastewater enters the sewage facility.
Again responding to industry suggestions, the IRS clarified in the final regulation that facilities used to treat "septage," or waste from septic tanks, qualify for tax-exempt financing, and septage treatment property is not subject to the BOD standard.
In addition, the regulations include a transition rule for refundings, stating that an issuer can choose whether to apply the regulations to such a transaction.
In the regulations, the IRS also made allowances for possible future technologies that might not fall under the rules as they stand.
"In light of potential future technological advances in wastewater treatment, the final regulations provide that the [IRS] Commissioner may determine that facilities using technologically advanced or innovative processes qualify as sewage facilities if these facilities perform functions that are consistent with the definition of sewage facilities contained in the final regulations," the service said.
