WASHINGTON -- A group of rural electric cooperatives that distribute electricity to farmers and businesses in Indiana cannot issue tax-exempt bonds because they are not political subdivisions, the Internal Revenue Service ruled last week.
Bond lawyers said the private letter ruling is not surprising and tracks a 1983 IRS revenue ruling and previous congressional debates on the matter. But the lawyer who requested the ruling said it contains a message for the bond community.
"The IRS wanted to send a message that they were not going to take a broad view of what constitutes a political subdivision," said Milton S. Wakschlag, a lawyer with Katten Muchin & Zavis in Chicago, the law firm that sought the ruling request on behalf of the cooperatives.
Mr. Wakschlag said he thought the IRS might conclude that these particular rural electric cooperatives were political subdivisions because they have some unique powers and features, such as the power to condemn property -- one of the traditional powers accorded to political subdivisions. And if they are dissolved, their property reverts to the state, he said.
Several lawyers said that, under case law, a political subdivision is any entity that has substantial amounts of police or the power to tax or to condemn. But one lawyer said this standard applies only if the entity is governmental, because most utilities have the power of condemnation.
"The question boiled down to whether the cooperatives were like municipal utilities or investor-owned utilities," he said, adding, "The IRS decided they were more like investor-owned utilities."
Neither the IRS ruling nor Mr. Wakschlag would identify the cooperatives, but other sources said they are all located in Indiana.
The cooperatives, which were created years ago to distribute electricity to farmers, businesses, and other rural customers, wanted the IRS to allow them to issue tax-exempt bonds to finance new distribution projects and to retire all or some of their outstanding debt.
But the IRS ruling cited a 1981 court case in which Temple University, a state university in Pennsylvania, was found to be neither a political subdivision nor an entity that could issue bonds "on behalf of" the state of Pennsylvania. The IRS said the court's ruling in Philadelphia National Bank v. United States was based in part on its reasoning "that if the interest on obligations of state-related schools is to be exempt from federal tax, that decision should be made by Congress rather than the court via a strained construction of section 103(a)" of the Internal Revenue Code.
"We also believe that a liberal definition of a political subdivision is generally unwarranted," the IRS said it its ruling on the Indiana cooperatives.
The IRS pointed out in the ruling that the federal government has provided other kinds of financial assistance for rural electric cooperatives, such as low-cost loans.
Mr. Wakschlag said he had argued before the IRS that the cooperatives should be considered a political subdivision, in part, because "they have a very broad representation of an entire population of an affected jurisdiction."
But the IRS said the cooperatives were neither owned nor operated by the state or any other governmental unit and added that membership in them is available only to those who pay fees to use the electricity they distribute. The IRS noted that "they are operated for the private benefit of their members."
Bond lawyers said there has been a long-standing debate about whether rural electric cooperatives should be considered political subdivisions or entities that can issue tax-exempt bonds on behalf of political subdivisions.
Congress has considered the matter in past years but has declined to enact legislation that would grant those cooperatives political subdivision status. Mr. Wakschlag pointed out that the issue is still alive in Congress and that several legislative proposals on both sides of the issue were pending this year.
The IRS issued a 1983 revenue ruling that revoked a previous ruling that had said electric cooperatives in North Carolina were political subdivisions. Mr. Wakschlag said the 1983 ruling was negative, in part, because the North Carolina cooperatives did not have full powers of condemnation.