Rev. Rul. 83-56

1983-1 C.B. 22.

                       Internal Revenue Service
                                 Revenue Ruling

     INDUSTRIAL DEVELOPMENT BONDS;  FACILITIES FOR THE LOCAL FURNISHING OF
                             ELECTRIC ENERGY OR GAS

                            Published: April 4, 1983

26 CFR 1.103-8: Interest on bonds to finance certain exempt facilities

  Industrial development bonds;  facilities for the local furnishing of electric energy or gas.  A hydroelectric generating plant that will be constructed to serve a single county is not a facility for the local furnishing of electricity, under section 103(b)(4)(E), when it is an integral part of the taxpayer's multi-county distribution system.

ISSUE

  Whether under section 103(b)(4)(E) of the Internal Revenue Code the hydroelectric generating plant described below is a part of a system providing service to the general populace of not more than two contiguous counties and therefore is a facility for the local furnishing of electricity, so that the interest on industrial development bonds issued to finance the property will be excludable from gross income?

FACTS

  The Developmental Authority (the Authority) of state Y is authorized under state law to issue revenue bonds for the purpose of promoting industrial development in the state.

  The Authority proposes to issue industrial development bonds the proceeds of which will be used to construct a hydro electric generating plant including site improvements, machinery, equipment, and related property to be used in connection with the generating and transmitting of electricity.  The plant will be owned by a regulated public utility and all property acquired or constructed will be of a character subject to the allowance for depreciation provided in section 167 of the Code and would qualify as recovery property under section 168.  A financing agreement between the Authority and the public utility will provide for aggregate semiannual payments sufficient to pay the principal and interest on the bonds.  The utility furnishes electric energy throughout its system in accordance with its obligation as imposed by the state public utility commission (Commission).  That system includes many counties of state Y.  The cost of operation of the new facility and the effect of the new facility on the rate base will be considered by the Commission in establishing the company's rates for the entire system.  These rates relate to all customers in the system (service area) and will be uniform to all customers of this utility within its designated rate categories.

  The proposed hydroelectric plant is to be located near a population center in a single county and the electric energy from the new facility will be supplied to the population center. However, the electrical needs of the population center will be supplemented from other generating plants in the utility's intra connected regional system.  These generating plants are also available to supply the power needs of the rest of the utility's intra connected system.  At the present time, all the electricity furnished to the population center is supplied by the other plants.

LAW AND ANALYSIS

  Section 103(a)(1) of the Code provides that the interest on obligations of states and political subdivisions of states is excludable from the gross income of the recipients.

  Section 103(b)(1) of the Code provides that industrial development bonds are not treated as obligations described in section 103(a) unless substantially all of the proceeds are used to provide facilities exempted by section 103(b)(4).

  Section 103(b)(4)(E) of the Code provides that facilities for the local furnishing of electric energy is one of the exempt categories.  Section 332 of the Revenue Act of 1978, 1978-3 (Vol. 1) C.B.74, amended this subparagraph to state that the local furnishing of electric energy from a facility shall include furnishing solely within the area consisting of a city and one contiguous county.

  Congress, by this amendment in the Revenue Act of 1978, expanded the two county limitation to include a city and one contiguous county and confirmed that the purpose of allowing section 103 financing for electric utilities is to benefit limited geographic service areas.  In affirming the restrictive interpretation intended the Conference Report states, "The conferees wish to make it clear that their agreement that local furnishing includes a city and a contiguous county provides an exception from the general rule that local furnishing means a service area comprising no more than two contiguous counties (or political equivalent)", emphasis added, H.R.Rep. No. 95-1800 (Conf. Rep.) 95th Cong., 2d Sess. 198(1978), 1978-3 (Vol. 1) C.B. 521, 573.

  Section 1.103-8(a)(2) of the Income Tax Regulations provides a public use requirement to qualify for the exemption granted by section 103(b)(4) of the Code.

  Section 1.103-8(f)(1)(ii) of the regulations further defines the public use test in section 1.103-8(a)(2) by stating that a facility for the local furnishing of electricity is available for use by members of the general public if (a) the owner or operator of the facility is obligated by a legislative enactment, local ordinance, regulation, or the equivalent thereof, to furnish electric energy or gas to all persons who desire such services and are within the service area of the owner or operator of such facility, and (b) it is reasonably expected that such facility will serve or be available to a large segment of the general public in such service area.

  Section 1.103-8(f)(2)(iii) of the regulations defines "facilities for the local furnishing of electric energy or gas" to mean property that-

    (a) is either property subject to the depreciation allowance provided in section 167, or is land,

    (b) is used to produce, collect, generate, transmit, store, distribute, or convey electric energy or gas,

    (c) is used in the trade or business of furnishing electric energy or gas, and

    (d) is part of a system providing service to the general populace of one or more communities or municipalities, but in no event more than two contiguous counties (or a political equivalent) whether or not these counties are located in one state.

  To qualify as a facility for the local furnishing of electric energy, under the restrictive interpretation intended by Congress, the facility must be part of a system providing service to the general population of no more than two contiguous counties (or a city and one contiguous county).  In this case, the utility as owner and operator of many generating plants (including the proposed hydroelectric generating plant) is under a regulatory obligation to provide electric energy to all persons within its service area.  The system referred to in section 1.103-8(f)(2)(iii)(d) of the regulations is that of the public utility.  It is composed of the property required to produce and deliver electricity to the service area of that utility as referred to in section 1.103-8(a)(2) and section 1.103-8(f)(1)(ii).  Therefore, since the new hydroelectric generating plant will increase the capability of the utility to service the general population in the service area, it will become part of the utility's system that serves more than two counties. This is true, even though there is a reasonable expectation that the demand for electric energy in the local population center (the single county) will exceed the output from the proposed plant.

  Furthermore, the benefits of lower interest costs for section 103 financing will not be limited to customers in the county area but they will affect the rates of all the customers in the utility's entire service area.  The rates charged by the utility are established by the Commission after consideration of the company's rate base and cost of service.  These rates, relating to all customers in the entire service area, will be applicable without distinction to energy to be generated by the new hydroelectric plant as well as all energy to be introduced into the utility's system from any source.

  In addition, the electric energy generated by the proposed facility will, under normal demand, simply replace electricity previously supplied from other plants in the company's regional system.  Such plants are connected and are available to supply power needs throughout that system.

HOLDING

  The hydroelectric generating plant, described above, will not be a facility for the local furnishing of electricity within the meaning of section 103(b)(4)(E) of the Code.  Therefore, the interest on industrial development bonds issued to finance the property will not be excludable from the gross income of the taxpayer under section 103(b)(4)(E) of the Code.

Rev. Rul. 83-56, 1983-1 C.B. 22.