WASHINGTON -- The Internal Revenue Service has ruled that the tax-exempt status of more than $550 million of bonds will not be jeopardized if a utility serving two California counties helps supply electricity to another utility's customers in a third county.
Several bond lawyers said the private letter ruling helps the municipal market because the IRS has not always ruled favorably on such cases.
Under current tax laws and regulations, utilities generally qualify for tax-exempt financing only if they serve two contiguous counties or a county and a contiguous city.
The bond lawyers agreed with Richard H. Nicholls, a lawyer with Mudge Rose Guthrie Alexander & Ferdon in New York City, who said the ruling represented a "good common sense" approach that helped resolve a power supply problem.
The letter ruling was published without identifying the utilities involved. But lawyers for San Diego Gas and Electric Co. confirmed last week that it was the utility that sought the ruling. The other utility was Southern California Edison Co., they said.
San Diego Gas and Electric, which provides electricity to customers in San Diego and Orange counties, sought the ruling after a small residential development in a remote area of San Diego County spilled over into Riverside County.
The new development in Riverside County was in Southern California Edison's service territory. But that utility could not easily supply the 20 to 40 new residences with electricity because it could not build transmission lines through the parkland and national forest that surrounded them.
A so-called border accommodation arrangement was proposed whereby San Diego Gas and Electric would supply the residences with electricity and, in return, receive electricity from Southern California Edison.
San Diego Gas and Electric worried, however, that since it would be supplying electricity to residences in a third county, six tax-exempt bond issues sold from 1983 to 1987 might lose their tax-exempt status.
But the IRS concluded in the letter ruling that the border accommodation arrangement would not jeopardize the tax-exempt status of the bonds.
In reaching its conclusion, the IRS said the border arrangement was "incidental to ]San Diego Gas and Electric's[ business of providing adequate, efficient, and economical electric service to the general public within the service area."
The IRS also said that while the border arrangement would result in some outbound flows of power, the utility would not supply any more power than it received on an annual basis.
In addition, the IRS said, San Diego Gas and Electric's rate payers would not be burdened with any costs related to the border accommodation arrangement.
Dean E. Criddle, a lawyer with the firm of Orrick, Herrington & Sutcliffe in San Francisco that represented San Diego Gas and Electric, said the ruling "was a very reasonable position for the IRS to take" and that not allowing the border arrangement would have been "extremely burdensome" and costly for Southern California Edison.
Mr. Criddle said the ruling amends a letter ruling San Diego Gas and Electric received from the IRS in 1983 that allowed two other such arrangements. In each case, the utility was serving a few customers of another utility in another county through a similar border accommodation arrangement.
Before issuing the 1983 ruling, the IRS told San Diego Gas and Electric it could face the loss of tax exemption for its bonds if it had customers in another county, but that it could supply them once they became the customers of another utility, Mr. Criddle said.
In the recent letter ruling, the IRS said it was revoking another letter ruling it issued last year on a proposed merger between San Diego Gas and Electric and Southern California Edison. The merger failed, so the IRS felt the ruling, which was now moot, should be withdrawn. In that ruling, the IRS had said San Diego Gas and Electric's bonds would remain tax exempt if the utility's service area expanded after the merger, as long as the bonds were redeemed or defeased and then redeemed at the first call date.