WASHINGTON -- The Internal Revenue Service has reissued a private letter ruling clarifying that a municipal electric authority can use tax-exempt bonds to finance improvements to a transmission system that moves power from a privately owned co-generation facility to a private electric utility.

Bond lawyers were pleased with the reissued ruling, PLR 9123038, saying it uses new facts to make it clearer that public utilities, in certain circumstances, can transmit power between private investor-owned utilities without running afoul of a private-use test that could make their bonds private-activity bonds and possibly taxable.

In the first ruling. PLR 9102046, which was published in January without identifying the parties involved, it was not clear from the facts presented that the bond proceeds were to be used to finance improvements to the transmission facilities.

According to that ruling, the bonds would be used to finance general improvements to the system, including capitalized interest. They also would be used for a reserve fund and to pay the costs of issuance from bonds issued in 1989 and bonds to be issued in 1991.

The reissued ruling makes clear that the improvements to be financed will be to transmission facilities used to transmit power from one private utility to another, as well as to the municipal electric authority's public customers.

Also, the second ruling contradicts the earlier ruling's suggestion that the rates for transmission of power to the private utilities would be based on transmission rates for residential customers. The reissued ruling says that "the charge for transmission is the same as the charge to any other customer for the purchase of firm transmission services," and it will be based on "the rates for wholesale sales of electricity pursuant to interchange contracts."

Some bond lawyers who were familiar with, but not involved in the ruling request, said that the ruling was reissued with new facts because the first ruling did not accurately represent the facts that had been relayed to the IRS by the taxpayer.

The rulings were signed by two different IRS officials. The first ruling was signed by Michael J. Montemurro, who headed the tax-exempt bond branch at the time. He has since left that post and has become chief of another branch at the IRS that generally does not deal with tax-exempt bond issues. The new ruling was signed by Michael G. Bailey, who became senior technician reviewer for the IRS bond branch last year.

The ruling was importnant for the municipal electric authority because a federal law that encourages conservation -- the Public Utility Regulatory Policies Act -- requires private and public utilities to purchase power, or help transmit power to other utilities, from "qualified" co-generation facilities. In this particular situation, according to the rulings, state law also required the authority to help transmit power from the co-generation facility.

The authority feared that by transmitting the power between investor-owned utilities, it would exceed the 10% private-use test or a separate loan test. Under the tax law, bonds can be ruled to be private-activity bonds that are subject to state volume limits or that are taxable if more than 10% of the proceeds are used to benefit private parties and more than 10% of the debt service is derived from, or secured by private payments.

Bonds also can be declared to be private-activity bonds if more than 5% of the proceeds or $5 million, whichever is less, are lent directly or indirectly to private parties.

The IRS concluded that if the municipal authority transmitted power between the private investor-owned utilities, the authority's electric system would not used in the trade or business of the private utilities. The ruling also found that the proceeds of the 1989 and bonds would not be considered to be used for private parties or to make or finance a loan to those parties.

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