[Federal Register Volume 71, Number 153 (Wednesday, August 9, 2006)]
[Proposed Rules]
[Pages 45474-45475]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-12884]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[REG-118788-06]
RIN 1545-BF63


Definition of Essential Governmental Function Under Section 7871 
and Limitation to Activities Customarily Performed by States and Local 
Governments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: This document applies to Indian tribal governments and to 
State and local governments that issue bonds for the benefit of Indian 
tribal governments. This document describes rules that the IRS and the 
Treasury Department anticipate proposing, in a notice of proposed 
rulemaking, regarding the definition of an essential governmental 
function under section 7871(c) of the Internal Revenue Code and the 
limitation of that term to activities customarily performed by State 
and local governments for purposes of section 7871(e) of the Internal 
Revenue Code. This document also invites comments from the public 
regarding this proposed standard.

DATES: Written or electronic comments must be submitted by November 7, 
2006.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-118788-06), Room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be sent electronically, via the 
IRS Internet site at http://www.irs.gov/regs or via the Federal 
eRulemaking Portal at http://www.regulations.gov (indicate IRS and REG-
118788-06).

FOR FURTHER INFORMATION CONTACT: Concerning submissions, Kelly Banks, 
(202) 927-1443; concerning the proposed rules, Timothy L. Jones or 
Aviva M. Roth, (202) 622-3980 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 7871(a)(4) of the Internal Revenue Code of 1986 provides 
that an Indian tribal government is to be treated as a State ``subject 
to subsection (c), for purposes of section 103 (relating to State and 
local bonds)''. Section 7871(c)(1) provides that ``section 103(a) shall 
apply to any obligation (not described in paragraph (2)) issued by an 
Indian tribal government (or subdivision thereof) only if such 
obligation is part of an issue substantially all of the proceeds of 
which are to be used in the exercise of any essential governmental 
function''. Section 7871(e) provides that ``[f]or purposes of this 
section, the term `essential governmental function' shall not include 
any function which is not customarily performed by State and local 
governments with general taxing powers''.
    Section 7871 was originally enacted in 1982 by The Indian Tribal 
Government Tax Status Act, Public Law 97-473, 96 Stat. 2605 Sec.  202 
(1983). In the legislative history to that Act, the Senate Finance 
Committee indicated that tax-exempt bond financing was not intended to 
be available to Indian tribal governments for ``commercial or 
industrial activities (or other activities other than essential 
governmental functions).'' S. Rep. No. 97-646, at 13-14 (1982).
    Section 7871(e) was added to the statute by The Omnibus Budget 
Reconciliation Act of 1987, Public Law 100-203, 101 Stat. 1330, Sec.  
10632(a) (1987). In the legislative history to this provision, the 
House Ways and Means Committee criticized 1984 Temporary Treasury 
Regulations interpreting the term essential governmental function in 
section 7871(c) for including certain activities eligible for Federal 
funding in that definition. The House Ways and Means Committee stated 
that the reason for this amendment was that the Committee was concerned 
about reports that Indian tribal governments were issuing tax-exempt 
bonds for interests in

[[Page 45475]]

``commercial and industrial enterprises''. The Committee further 
included the following statement about section 7871(e):

    The bill clarifies that, with respect to bonds issued by Indian 
tribal governments, the term `essential governmental function' does 
not include any governmental function that is not customarily 
performed (and financed with governmental tax-exempt bonds) by State 
and local governments with general taxing powers. For example, 
issuance of bonds to finance commercial or industrial facilities 
(e.g., private rental housing, cement factories, or mirror 
factories) which bonds technically may not be private activity bonds 
is not included within the scope of the essential governmental 
function exception.
    Additionally, the committee wishes to stress that only those 
activities that are customarily financed with governmental bonds 
(e.g., schools, roads, governmental buildings, etc.) are intended to 
be within the scope of this exception, notwithstanding that isolated 
instances of a State or local government issuing bonds for another 
activity may occur.

H.R. Rep. No. 100-391, at 1139 (1987).
    The 1987 Conference Committee adding the limited manufacturing 
facility provision of section 7871(c)(3)(A), noted that:

    A facility which does not qualify as a manufacturing facility 
for purposes of this provision may nonetheless be financed with tax-
exempt bonds issued by a tribal government provided that the 
facility satisfies the `essential governmental function' standard 
(i.e., the facility is comparable to facilities that are customarily 
acquired or constructed and operated by States and local 
governments). For example, a building used for offices for a tribal 
government itself would be comparable to State or local government 
office buildings, and therefore, could be financed with tax-exempt 
bonds. As another example, a lodge owned and operated by a tribal 
government may be eligible for tax-exempt financing if it is 
comparable to lodges customarily owned and operated by State park or 
recreation agencies.

H.R. Rep. No. 100-495, at 1012 n.5 (1987) (Conf. Rep.).
    The IRS has become aware of an increasing number of instances in 
which taxpayers have raised questions about the application of section 
7871(e). Accordingly, the Treasury Department and the IRS have 
determined to seek public comment in advance of issuing proposed 
regulations in this area.

Explanation of Provisions

    The Treasury Department and the IRS anticipate that the proposed 
regulations will provide that for purposes of section 7871(c) and 
section 7871(e), an activity will be considered an essential 
governmental function that is customarily performed by State and local 
governments if: (1) There are numerous State and local governments with 
general taxing powers that have been conducting the activity and 
financing it with tax-exempt governmental bonds, (2) State and local 
governments with general taxing powers have been conducting the 
activity and financing it with tax-exempt governmental bonds for many 
years, and (3) the activity is not a commercial or industrial activity. 
The proposed regulations will further provide that examples of 
activities customarily performed by State and local governments 
include, but are not limited to, public works projects such as roads, 
schools, and government buildings.

Request for Comments

    Before the notice of proposed rulemaking is issued, consideration 
will be given to any written comments that are submitted timely 
(preferably a signed original and eight (8) copies) to the IRS. All 
comments will be available for public inspection and copying.

Drafting Information

    The principal authors of this advance notice of proposed rulemaking 
are Aviva M. Roth and Timothy L. Jones, Office of the Chief Counsel 
(Tax-exempt and Government Entities), however, other personnel from the 
IRS and Treasury Department participated in its development.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
 [FR Doc. E6-12884 Filed 8-8-06; 8:45 am]
BILLING CODE 4830-01-P