A municipal power plant can be financed partly in the tax-exempt bond market, the IRS said, even though a private power company operates the plant and takes part of the electricity under a long-term contract.

This may open the door to some new financing strategies for projects where a municipality is prepared to take only part of the electricity output.

The IRS said in a private ruling made public in July that a municipal utility could use tax-exempt bonds to pay the cost of new power plant that the municipal utility plans to own. The utility will let an electric cooperative operate the plant and sell the coop a share of the power under a long-term power purchase agreement. The IRS said the municipality could use tax-exempt financing for a fraction of the plant cost. The fraction is the expected share of the electricity that the municipal utility will retain over the term of the bonds as a percentage of nameplate capacity,

Tax-exempt bonds usually cannot be issued for projects that are put to more than 10% “private business use.” It is a private business use to sell the output to a private party, including an electric cooperative, under a bilateral contract. It may also be a private business use to let a private party operate the plant. However, in this case the IRS said the fact that the coop was the contract operator was not a problem because the municipal utility planned only to reimburse the coop for the actual costs to operate and then only for a share of those costs equal to the share of plant capacity retained by the municipal utility.

The ruling is Private Letter Ruling 201128010.

Keith Martin