A Municipal Utility

A Municipal Utility

December 01, 2004

A municipal utility cannot be given an interest in a power plant or sold a turbine that is already under construction without tax complications.

Municipal utilities must be careful when buying equipment not to buy any that has already been “used (or held for use)” by a private company in connection with a power plant or other “output facility.” The problem with buying such equipment is the municipal utility may have a hard time using funds borrowed in the tax-exempt bond market to make the purchase. Most municipal utility borrowing is in the tax-exempt bond market. It may be hard to segregate where a municipal utility’s money has come from.

Congress said when it enacted these rules that a power plant is considered “held for use” – even if it has not been put into service – if it was built for an investor-owned utility or independent power company.

An independent power company ordered four turbine-generator sets, but then realized it had no use for them. A municipal utility put out a request for proposals to turbine suppliers. The independent power company made the low bid to supply the municipal utility with the turbines the utility needed. It did so by assigning the contract with its manufacturer.

The turbines were in the early stages of assembly at the time at the factory and no components had been delivered yet to the project sites.

The IRS confirmed in a private ruling that the agency made public in late November that the turbines could be sold to the municipal utility because they were not yet “held for use.” An important factor in the decision was that the turbines were not customized, but were “mass-produced” turbines using a standard design. The ruling is PLR 200448017.

The ruling is important for project developers who are having a hard time finding utilities to sign long-term contracts to buy electricity from projects on which they are working in the US. Without such contracts, the projects are very difficult to finance. Some developers have turned to trying to stitch together a series of smaller contracts with municipal utilities and electric cooperatives. Such buyers prefer to own an interest in the power plant and to take a share of the electricity in kind (rather than buy it). Thus, developers have been driven to structures where each of the municipal utilities and cooperatives owns an “undivided interest” in the power plant. Each then separately finances its part of the power plant. Coops and municipal utilities can usually borrow at lower rates than private developers.

The IRS ruling suggests that municipal utilities need to be part owners of the plant before construction starts.