Public Power Groups Weigh In On Bond Private Use Rules

by Paul Ciampoli
APPA News Director
May 11, 2022

The American Public Power Association (APPA) and the Large Public Power Council (LPPC) recently sent a letter to Tom West, Deputy Assistant Secretary for Tax Policy at the U.S. Treasury Department, related to bond private use rules.

The May 3 letter follows a meeting in April with West, his staff, and personnel from the Internal Revenue Service to discuss the issue. The letter was signed by LPPC President John Di Stasio and APPA President and CEO Joy Ditto.

It has been over 30 years since the enactment of private use rules for public power in the Tax Reform Act of 1986 and nearly 20 years since the related regulations in Section 141 for output facilities were updated, the letter noted.

“The changes to the regulations that were made in 2002 were, in part, made in response to significant changes that had occurred in the electric industry. Given the changes that have occurred in the electric industry since 2002, the private use rules need to be modified again,” wrote Ditto and Di Stasio.

APPA and LPPC are focused on the two most significant issues affecting public power: the impact of output contracts with large retail customers and the issues created by the section 141(d) “Rostenkowski Rule” on the ability of the members of the groups to use tax-exempt bonds to acquire existing electric resources needed to serve their customers.    

Contracts With Retail Customers

A growing trend in the industry is that large retail electric customers — both existing customers and new customers — are seeking to negotiate customized contracts for electric service with public power and other utilities. Private use rules limit the ability of public power utilities to enter into customized contracts and put them at the risk of losing these important customers.

“These customers can be extremely important to their communities and the inability provide them with satisfactory electric service arrangements could be devastating for both the utility and the local community. At the same time, if these customers are not obligated to remain as customers for a significant enough period, the utility and its other customers are at risk that they will bear the cost of the improvements required to serve these customers if they go out of business or relocate,” the letter said.

Under current regulations, the only approach that can be used by public power utilities with large, retail customers is to enter into contracts with terms of not more than three years, which is not sufficient for the public power utility to ensure that its other customers will end up bearing the cost of any necessary improvements and often does not provide a long enough contract term for the customer.

“Oddly, the regulations contain a more generous rule for contracts with wholesale customers that permits contracts, subject to certain conditions, with terms of up to five years,” Ditto and Di Stasio said.

APPA and LPPC proposed the adoption of an exception to the private use rules for contracts with retail customers that tracks the requirements for short-term contracts in section 1.141-7(f)(3) and that would apply if:      

• The term of the contract is not more than 10 years (including renewal options); 
• The contract either is a negotiated, arm’s-length arrangement that provides for compensation at fair market value, or is based on generally applicable and uniformly applied rates; and
• The output facility is not financed for a principal purpose of providing that facility for use by that nongovernmental person.

“We believe that an expansion of the short-term use rule as described above as not giving rise to private use is consistent with both the underlying regulatory framework of the output regulations (i.e., such a contract does not shift the ‘benefits and burdens of ownership’ to the taker), and Treasury’s economic policy of accommodating certain industry changes to foster competition,” Ditto and Di Stasio said.

Acquiring Existing Output Facilities

The letter notes that Section 141(d) (the “Rostenkowski Rule”) was enacted in 1987 and regulatory guidance on this provision has yet to be provided.

Although designed to prevent tax-exempt bonds from being used to “municipalize” privately owned facilities, the rule contains an exception designed to permit the acquisition of existing facilities by a public power utility to serve its existing customers — the “Existing Service Area Exception.”

“This exception is very difficult and burdensome for utilities to apply: it requires that the utility use virtually all of the electricity from the acquired facility to serve customers in its historic service area throughout the term of the bond issue and monitor compliance with this rule,” wrote Ditto and Di Stasio.

The Existing Service Area Exception was meant to permit public power utilities to use tax-exempt bonds to acquire electric facilities that were to be used to serve the existing customers of the acquiring utility.

The requirement that 95 percent of the electricity from the acquired facility be used to serve those existing customers subject only to the ability to make non-service area sales with terms of up to 30 days has significantly limited the use of this exception and prevented public power utilities from using tax-exempt bonds to acquire facilities despite the underlying rationale for the Existing Service Area Exception.

The Existing Service Area Exception presents practical and economic issues that make it difficult and costly to comply with, the letter said.

The public power groups said that many public power utilities that have short-term excess energy to sell make those sales on a “system” basis, meaning that the electricity being sold does not come from any particular generating unit. 

As a result, even with on-going monitoring, it is difficult to prevent the electricity from a facility that is subject to 141(d) from being sold outside the utility’s service area without restricting the entire system. 

A second, related difficulty is that in making system sales, all of a utility’s electricity derived from other bond-financed generating facilities can be sold for up to three years, but the facility that is subject to section 141(d) prevents the utility from making system sales of more than 30 days because of the need to comply with section 141(d).  

The existing three-year short-term sale exception that applies for other output sales for purposes of section 141 was included in the regulations so that private use rules did not impact the typical, day-to-day functioning of public power utilities. 

This private use exception is consistent with the “benefits and burdens” framework of the output regulations.  

As an example of the problem with a 30-day exception under Section 141(d), short-term sales of electricity are often made on a seasonal basis to reflect situations, such as a utility that has its peak load during warm months may have excess electricity in the winter.

Ditto and Di Stasio suggested two possible approaches that can be used to address these issues. The first is to simply provide that the existing short-term sale exception to private use of output facilities applies to section 141(d).

Alternatively, a safe harbor could be adopted that permits public power utilities to base compliance on either reasonable expectations or based on historical use of electric generation to satisfy customers in their historic service areas, the groups said.

This approach would be modeled after section 148(b)(4)(B), related to bonds issued to finance natural gas prepayments.

“The rule based on historical use has proven to be very workable. Under this approach, a new safe harbor would permit public power utilities to use their historic sales of electricity in their service areas to determine compliance with the existing service area exception of the Rostenkowski Rule,” the letter said.