WASHINGTON -- A recent letter ruling published by the Internal Revenue Service will make it easier for issuers to sell tax-exempt governmental bonds to partly finance facilities that produce electricity, gas, or water for use by both public and private entities, lawyers said yesterday.

The IRS ruling, published last week, concludes that a municipal utility district could issue tax-exempt governmental bonds to finance improvements to the portion of its hydroelectric generating facilities that supplies power to other public utilities under take-or-pay contracts.

The IRS made that finding even though a significant amount of the output of the facilities is also sold to private utilities under the same kinds of contracts.

The ruling further concluded that the utility district could determine how much of the output would be used for governmental purposes based on the district's reasonable expectations that it would be relicensed by a federal commission and that it would continue to supply power to the public utilities under new contracts that would become effective while the bonds were still outstanding.

It also concluded that the public utility district could issue tax-exempt governmental and tax-exempt private-activity bonds at the same time to finance the improvements, but treat them as separate issues for purposes of meeting private-activity bond requirements. The utility district did not want the governmental bonds to be subjected to alternative minimum tax and volume cap requirements that the private-activity bonds would have to meet.

Bond lawyers were elated at the ruling, which they said charts new ground and provided flexibility in applying the tax law to such facilities.

"It's an important ruling for output facilities and for public power in particular," said Dean Criddle, a lawyer with Orrick, Herrington & Sutcliffe in San Francisco, the firm that requested the ruling on behalf of a client it would not identity.

"It is important," agreed Richard Nicholls, a lawyer with Mudge Rose Guthrie Alexander & Ferdon in New York City. Mr. Nicholls said that "it's been a little unclear" until now whether an issuer could use reasonable expectations to determine the extent to which bond-finance facilities would be governmentally or privately used.

The IRS ruling contained the usual disclaimer that it was directed only at the taxpayer that requested it. The ruling did not identify the taxpayer.

But lawyers said the ruling will be relied upon because it clarifies the IRS' stance in an area where other guidance has not been available. They also said the ruling contains some broad statements that could be generally applied to output facilities.

The IRS said in the ruling, for example, that "we believe that the underlying purposes of the special rules applicable to output facilities is to provide state and local governments with the practical flexibility to finance output facilities for their own needs, taking into account [their] unique nature."

One bond lawyer, who was not involved in the ruling request, said the ruling was for the Grant Public Utility District in Washington State. Criddle declined to confirm that, but agreed to discuss the ruling in general.

The public utility district had hydroelectric generating facilities that had been operating since the 1960s. They needed to be serviced, upgraded, and retrofited with environmental mitigation equipment. Federal environmental laws require that the dam be fitted with fish ladders or other equipment so that the fish would not be ground up by the turbines.

The utility district planned to use a special rule contained in the Tax Reform Act of 1986 that allowed it to issue tax-exempt private-activity bonds for these kinds of improvements.

But the utility district wanted to issue tax-exempt governmental bonds for the portion of the facilities that produces power that is sold to public utilities. Governmental bonds can be issued without regard to state volume limits or alternative minimum tax requirements, but private-activity bonds would be subject to both these tax law requirements.

The utility district also faced the problem that its license from the Federal Energy Regulatory Commission and its contracts with all the public and private utilities would expire before the bonds would mature. The utility district's forecasts showed it would have excess hydroelectric power at that time that it would want to sell to the public utilities. But the utility could not guarantee that its license would be renewed or that it would be able to enter into new contracts to sell power to the public utilities.

The utility also wanted to sell the tax-exempt governmental and private activity bonds at the same time but as separate issues. Under the tax laws, two or more bond issues are considered to be a combined, single issue under private-activity bond rules if the bonds are sold at substantially the same time, pursuant to a common plan of marketing, and at substantially the same rate of interest. In addition, the bonds must have a common or pooled security that is used, or is available, to pay debt service.

The district argued that since the private-activity bonds were subject to the alternative minimum tax, they would carry a higher rate of interest and would be sold to investors who believed they would not be subject to the minimum tax.

The IRS agreed and ruled that treating the bonds "as separate issues accurately reflects the economic substance of the financing and does not have the effect of avoiding the purposes" of the tax laws governing private-activity bonds.

The IRS also ruled the district could issue tax-exempt governmental bonds based on its expectations about the governmental use of the facilities. The IRS said that "Congress implicitly recognized that, because of such concerns as the cost effectiveness of economies of scale and the need to plan for utility needs far in advance, output facilities financed with tax-exempt bonds will commonly be used by both public and private users."

The IRS said also that "the allocation of private business use of a shared-use output facility may be based upon the issuer's good-faith reasonable expectations about its own future requirements." In this case, the IRS said, "the district's medium growth load forecast is the appropriate standard" upon which the district's expectations can be based.

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