[Federal Register Volume 81, Number 35 (Tuesday, February 23, 2016)]
[Proposed Rules]
[Pages 8870-8874]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-03790]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-129067-15]
RIN 1545-BM99
Definition of Political Subdivision
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations that provide
guidance regarding the definition of political subdivision for purposes
of tax-exempt bonds. The proposed regulations are necessary to specify
the elements of a political subdivision. The proposed regulations will
affect State and local governments that issue tax-exempt bonds and
users of property financed with tax-exempt bonds. Under certain
transition rules, however, the proposed definition of political
subdivision will not apply for determining whether outstanding bonds
are obligations of a political subdivision and will not apply to
existing entities for a transition period. This document also provides
a notice of a public hearing for these proposed regulations.
DATES: Written or electronic comments must be received by May 23, 2016.
Request to speak and outlines of topics to be discussed at the public
hearing scheduled for June 6, 2016, at 10:00 a.m., must be received by
May 23, 2016.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-129067-15), Internal
Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered to: CC:PA:LPD:PR Monday
through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR
(REG-129067-15), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue NW., Washington, DC, or sent electronically via the
Federal eRulemaking Portal at www.regulations.gov (REG-129067-15). The
public hearing will be held at the Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Spence Hanemann at (202) 317-6980; concerning submissions of comments
and the hearing, Oluwafunmilayo (Funmi) Taylor at (202) 317-6901 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to 26 CFR part 1 under
section 103 of the Internal Revenue Code (Code). Section 103 generally
provides that, with certain exceptions, gross income does not include
interest on any obligation of a State or political subdivision thereof.
Section 1.103-1 of the Income Tax Regulations (the Existing
Regulations) defines political subdivision as ``any division of any
State or local governmental unit which is a municipal corporation or
which has been delegated the right to exercise part of the sovereign
power of the unit.''
On a few occasions, Federal courts have ruled on whether an entity
qualifies as a political subdivision. E.g., Philadelphia Nat'l Bank v.
United States, 666 F.2d 834 (3d Cir. 1981); Comm'r of Internal Revenue
v. White's Estate, 144 F.2d 1019 (2d Cir. 1944). The IRS has also
addressed this issue in revenue rulings, most recently in 1983. E.g.,
Rev. Rul. 83-131 (1983-2 CB 184); Rev. Rul. 78-138 (1978-1 CB 314).
Because the results in these revenue rulings generally turn on the
unique facts and circumstances of the individual cases, numerous
entities have sought and received letter rulings on whether they are
political subdivisions. Letter rulings, however, are limited to their
particular facts, may not be relied upon by taxpayers other than the
taxpayer that received the ruling, and are not a substitute for
published guidance. See 26 U.S.C. 6110(k)(3) (2015) (providing
generally that a ruling, determination letter, or technical advice
memorandum may not be used or cited as precedent).
Commenters have requested additional published guidance, to be
applied prospectively, on which facts and circumstances are germane to
an entity's status as a political subdivision. The Treasury Department
and IRS recognize the need to clarify the definition of political
subdivision to provide greater certainty to prospective issuers and to
promote greater consistency in how the definition is applied across a
wide range of factual situations. These proposed regulations (the
Proposed Regulations) would provide a new definition of political
subdivision for purposes of tax-exempt bonds and would update and
streamline other portions of the Existing Regulations. The definition
of political subdivision in the Proposed Regulations does not apply in
determining whether an entity is treated as a political subdivision of
a State for purposes of section 414(d) of the Code.
Explanation of Provisions
1. Definition of Political Subdivision
The Proposed Regulations clarify and further develop the
eligibility requirements for a political subdivision. To qualify as a
political subdivision under the Proposed Regulations, an entity must
meet three requirements, taking into account all of the facts and
circumstances: sovereign powers, governmental purpose, and governmental
control. The Proposed Regulations also authorize the Commissioner to
set forth in future guidance to be published in the Internal Revenue
Bulletin additional circumstances in which an entity qualifies as a
political subdivision.
A. Sovereign Powers
The Proposed Regulations continue, without substantive change, the
longstanding requirement that a political subdivision be empowered to
exercise at least one of the generally recognized sovereign powers. The
three sovereign powers recognized for this purpose are eminent domain,
police power, and taxing power. See Comm'r of Internal Revenue v.
Shamberg's Estate, 144 F.2d 998 (2d Cir. 1944). The entity must be able
to exercise a substantial amount of at least one of these powers. See,
e.g., Rev. Rul. 77-164 (1977-1 CB 20); Rev. Rul. 77-165 (1977-1 CB 21).
B. Governmental Purpose
In determining whether an entity is a political subdivision, the
case law and administrative guidance interpreting the definition of
political subdivision in the Existing Regulations commonly consider
whether the entity serves a public purpose. Historically, the
determination of whether an entity serves a public purpose has focused
on the purpose for which the entity was
[[Page 8871]]
created, usually as set forth in the legislation authorizing creation
of the entity, rather than on the entity's conduct after its creation.
See, e.g., Shamberg's Estate, 144 F.2d at 1004. The Proposed
Regulations require that a political subdivision serve a governmental
purpose. A governmental purpose requires, among other things, that the
purpose for which the entity was created, as set out in its enabling
legislation, be a public purpose and that the entity actually serve
that purpose. It also requires that the entity operate in a manner that
provides a significant public benefit with no more than incidental
benefit to private persons. Cf., Rev. Rul. 90-74 (1990-2 CB 34)
(applying an ``incidental private benefit'' standard for purposes of
determining whether income is included in gross income under section
115(1)).
C. Governmental Control
The Proposed Regulations provide that a political subdivision must
be governmentally controlled. The Proposed Regulations provide rules
for determining both what constitutes control and which parties must
possess that control.
i. Definition of Control
The Proposed Regulations define control to mean ongoing rights or
powers to direct significant actions of the entity. Rights or powers to
direct the entity's actions only at a particular point in time are not
ongoing and, therefore, do not constitute control. For example, the
right to approve an entity's plan of operation as a condition of the
entity's formation is not an ongoing right. To constitute control, a
collection of rights and powers must enable its holder to direct the
significant actions of the entity.
The Proposed Regulations provide three non-exclusive benchmarks of
rights or powers that constitute control: (1) The right or power both
to approve and to remove a majority of an entity's governing body; (2)
the right or power to elect a majority of the governing body of the
entity in periodic elections of reasonable frequency; or (3) the right
or power to approve or direct the significant uses of funds or assets
of the entity in advance of that use. Aside from these three
arrangements, the determination of whether a collection of rights and
powers constitutes control will depend on the facts and circumstances.
Neither the right to dissolve an entity nor procedures designed to
ensure the integrity of the entity but not to direct significant
actions of the entity are control. Cf., Rev. Rul. 69-453 (1969-2 CB
182) (addressing procedures that do not constitute control in the
context of instrumentalities).
ii. Control Vested in a State or Local Governmental Unit or an
Electorate
Control by a small faction of private individuals, business
corporations, trusts, partnerships, or other persons is fundamentally
not governmental control. Therefore, the Proposed Regulations generally
require that control be vested in either a general purpose State or
local governmental unit or in an electorate established under an
applicable State or local law of general application. If, however, a
small faction of private persons controls an electorate, that
electorate's control of the entity does not constitute governmental
control of the entity. Accordingly, the Proposed Regulations provide
that an entity controlled by an electorate is not governmentally
controlled when the outcome of the exercise of control is determined
solely by the votes of an unreasonably small number of private persons.
The determination of whether the number of private persons
controlling an electorate is unreasonably small generally depends on
all of the facts and circumstances. To provide certainty, the Proposed
Regulations limit application of this facts and circumstances test to
situations that fall between two quantitative measures of concentration
in voting power. The number of private persons controlling an
electorate is always unreasonably small if the combined votes of the
three voters with the largest shares of votes in the electorate will
determine the outcome of the relevant election, regardless of how the
other voters vote. The number of private persons controlling an
electorate is never unreasonably small if determining the outcome of
the relevant election requires the combined votes of more voters than
the 10 voters with the largest shares of votes in the electorate. For
example, control can always be vested in any electorate comprised of 20
or more voters that each have the right to cast one vote in the
relevant election without giving rise to a private faction. For
purposes of applying these measures of concentration in voting power,
related parties are treated as a single voter and the votes of the
related parties are aggregated.
iii. Possible Relief for Development Districts
Some observers have suggested that, despite private control,
development districts should be political subdivisions during an
initial development period in which one or two private developers elect
the district's governing body and no other governmental control exists.
The Treasury Department and IRS recognize that the governmental control
requirement may present challenges for such development districts. In
these circumstances, the Treasury Department and IRS are concerned
about the potential for excessive private control by individual
developers, the attendant impact of excessive issuance of tax-exempt
bonds, and inappropriate private benefits from this Federal subsidy.
The Treasury Department and IRS seek public comment on whether it is
necessary or appropriate to permit such districts to be political
subdivisions during an initial development period; how such relief
might be structured; what specific safeguards might be included in the
recommended relief to protect against potential abuse; and whether the
proposed prospective effective dates and transition periods in Sec.
1.103-1(d) of the Proposed Regulations provide sufficient relief.
2. Streamlining Amendments
In addition to amending the definition of political subdivision,
paragraphs (a) and (b) of the Proposed Regulations update the
references in the general provisions of the Existing Regulations to
reflect changes to the Code made in the Tax Reform Act of 1986, Public
Law 99-514, 100 Stat. 2085, and other laws and regulations since the
promulgation of the longstanding Existing Regulations. The Proposed
Regulations also streamline these provisions. In general, the Treasury
Department and the IRS intend that these proposed amendments not change
the meaning of the Existing Regulations. The last sentence of Sec.
1.103-1(a) of the Proposed Regulations, however, clarifies that the
continued tax-exemption of an issue of bonds depends on its issuer's
continued status as a qualifying issuer of tax-exempt bonds. The
Treasury Department and IRS seek comments on the need for remedial
action provisions in the event the entity ceases to qualify as a
political subdivision and on the substance of any such provisions.
3. Applicability Dates and Reliance on Proposed Regulations
Subject to certain transition rules, the Proposed Regulations
generally would apply to all entities for all purposes of the tax-
exempt bond provisions of sections 103 and 141 to 150 beginning 90 days
after the Proposed Regulations are finalized. In order to ease hardship
that may arise from the new definition
[[Page 8872]]
of political subdivision, under proposed transition rules, that
definition would not apply for purposes of determining whether
outstanding bonds and refunding bonds in which the weighted average
maturity is not extended continue to be obligations of a political
subdivision. While these transition rules for outstanding bonds and
refunding bonds would apply for the purpose of determining whether
these bonds continue to be obligations of a political subdivision, the
new proposed definition of political subdivision would apply for other
purposes under sections 103 and 141 to 150, such as whether a new
entity that subsequently became a user of a project financed with such
bonds qualified as a State or local governmental unit for purposes of
section 141. Furthermore, under another proposed transition rule that
would apply to entities in existence prior to 30 days after the
Proposed Regulations are published, the proposed definition of
political subdivision would not apply for any purpose until three years
and ninety days after the Proposed Regulations are finalized. This
three-year transition period provides existing entities an opportunity
to restructure as necessary to satisfy the new definition of political
subdivision and allows existing entities to continue to issue new bonds
during the transition period. To enhance certainty, an issuer also may
choose to apply the definition of political subdivision in Sec. 1.103-
1(c) in the final regulations in circumstances in which that definition
otherwise would not apply under the transition rules.
In addition, prior to the applicability date of the final
regulations, issuers may elect to apply the definition of political
subdivision in Sec. 1.103-1(c) of the Proposed Regulations in whole,
but not in part, for any purpose of sections 103 and 141 through 150,
provided such use is applied consistently for all purposes of sections
103 and 141 through 150 to any given entity.
Special Analyses
Certain IRS regulations, including this one, are exempt from the
requirements of Executive Order 12866, as supplemented and reaffirmed
by Executive Order 13563. Therefore, a regulatory impact assessment is
not required. It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to
these regulations, and because these regulations do not impose a
collection of information on small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of
the Code, this notice of proposed rulemaking has been submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small entities.
Comments and Public Hearing
Before these Proposed Regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ``Addresses''
heading. The Treasury Department and the IRS request comments on all
aspects of the proposed rules. All comments will be available at
www.regulations.gov or upon request.
A public hearing has been scheduled for June 6, 2016, at 10:00
a.m., in the Auditorium of the Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC. Due to building security
procedures, visitors must enter at the Constitution Avenue entrance. In
addition, all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be admitted
beyond the immediate entrance area more than 30 minutes before the
hearing starts. For more information about having your name placed on
the building access list to attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit an outline of
the topics to be discussed and the time to be devoted to each topic by
May 23, 2016. Submit a signed paper or electronic copy of the outline
as prescribed in this preamble under the ``Addresses'' heading. A
period of 10 minutes will be allotted to each person for making
comments. An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed. Copies
of the agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these regulations are Spence Hanemann and
Timothy Jones, Office of Associate Chief Counsel (Financial
Institutions and Products), IRS. However, other personnel from the IRS
and the Treasury Department participated in their development.
Availability of IRS Documents
IRS revenue rulings cited in this notice of proposed rulemaking are
made available by the Superintendent of Documents, U.S. Government
Printing Office, Washington, DC 20402.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.103-1 is revised to read as follows:
Sec. 1.103-1 Interest on State or local bonds.
(a) Interest on State or local bonds. Under section 103(a), except
as otherwise provided in section 103(b), gross income does not include
interest on any State or local bond. Under section 103(c), the term
State or local bond means any obligation (as defined in Sec. 1.150-
1(b)) of a State (including for this purpose the District of Columbia
or any possession of the United States) or a political subdivision
thereof (a State or local governmental unit). Obligations issued by or
on behalf of any State or local governmental unit by a constituted
authority empowered to issue such obligations are the obligations of
such a unit. An obligation qualifies as a State or local bond so long
as the issuer of that obligation remains a State or local governmental
unit or a constituted authority.
(b) Certain limitations on interest exclusion. Under section
103(b), the interest exclusion in section 103(a) is inapplicable to a
private activity bond under section 141(a) (unless the bond is a
qualified bond under section 141(e)), an arbitrage bond under section
148, or a bond which does not meet the applicable requirements of
section 149.
(c) Definition of political subdivision--(1) In general. The term
political subdivision means an entity that meets each of the
requirements of paragraphs (c)(2) (sovereign powers), (c)(3)
(governmental purpose), and (c)(4) (governmental control) of this
section, taking into account all of the facts and circumstances, or
that is described in published guidance issued pursuant to paragraph
(c)(5) of this section. Entities that may qualify as political
subdivisions include, among others, general purpose governmental
entities, such as cities and counties (whether or not incorporated as
municipal corporations), and special purpose governmental entities,
such as special assessment districts that provide for
[[Page 8873]]
roads, water, sewer, gas, light, reclamation, drainage, irrigation,
levee, school, harbor, port improvements, and other governmental
purposes for a State or local governmental unit.
(2) Sovereign powers. Pursuant to a State or local law of general
application, the entity has a delegated right to exercise a substantial
amount of at least one of the following recognized sovereign powers of
a State or local governmental unit: The power of taxation, the power of
eminent domain, and police power.
(3) Governmental purpose. The entity serves a governmental purpose.
The determination of whether an entity serves a governmental purpose is
based on, among other things, whether the entity carries out the public
purposes that are set forth in the entity's enabling legislation and
whether the entity operates in a manner that provides a significant
public benefit with no more than incidental private benefit.
(4) Governmental control. A State or local governmental unit
exercises control over the entity. For this purpose, control is defined
in paragraph (c)(4)(i) of this section and a State or local
governmental unit exercises such control only if the control is vested
in persons described in paragraph (c)(4)(ii) of this section.
(i) Definition of control. Control means an ongoing right or power
to direct significant actions of the entity. Rights or powers may
establish control either individually or in the aggregate. Among rights
or powers that may establish control, an ongoing ability to exercise
one or more of the following significant rights or powers, on a
discretionary and non-ministerial basis, constitutes control: the right
or power both to approve and to remove a majority of the governing body
of the entity; the right or power to elect a majority of the governing
body of the entity in periodic elections of reasonable frequency; or
the right or power to approve or direct the significant uses of funds
or assets of the entity in advance of that use. Procedures designed to
ensure the integrity of the entity but not to direct significant
actions of the entity are insufficient to constitute control of an
entity. Examples of such procedures include requirements for submission
of audited financial statements of the entity to a higher level State
or local governmental unit, open meeting requirements, and conflicts of
interest limitations.
(ii) Control vested in a State or local governmental unit or an
electorate. Control is vested in persons described in paragraphs
(c)(4)(ii)(A) or (c)(4)(ii)(B) of this section or a combination
thereof:
(A) A State or local governmental unit possessing a substantial
amount of each of the sovereign powers and acting through its governing
body or through its duly authorized elected or appointed officials in
their official capacities; or
(B) An electorate established under applicable State or local law
of general application, provided the electorate is not a private
faction (as defined in paragraph (c)(4)(iii) of this section).
(iii) Definition of private faction--(A) In general. A private
faction is any electorate if the outcome of the exercise of control
described in paragraph (c)(4)(i) of this section is determined solely
by the votes of an unreasonably small number of private persons. The
determination of whether a number of such private persons is
unreasonably small depends on all of the facts and circumstances,
including, without limitation, the entity's governmental purpose, the
number of members in the electorate, the relationships of the members
of the electorate to one another, the manner of apportionment of votes
within the electorate, and the extent to which the members of the
electorate adequately represent the interests of persons reasonably
affected by the entity's actions. For purposes of this definition, the
special rules in paragraphs (c)(4)(iii)(B) through (D) of this section
apply.
(B) Treatment of certain limited electorates as private factions.
An electorate is a private faction if any three private persons that
are members of the electorate possess, in the aggregate, a majority of
the votes necessary to determine the outcome of the relevant exercise
of control.
(C) Safe harbor--voting power dispersed among more than 10 persons.
An electorate is not a private faction if the smallest number of
private persons who can combine votes to establish a majority of the
votes necessary to determine the outcome of the relevant exercise of
control is greater than 10 persons. For example, if an electorate
consists of 20 private persons with equal, five-percent shares of the
total votes, that electorate is not a private faction because a minimum
of 11 members of that electorate is necessary to have a majority of the
votes. By contrast, for example, if an electorate consists of 20
private persons with unequal voting shares in which some combination of
10 or fewer members has a majority of the votes, then that electorate
does not qualify for the safe harbor from treatment as a private
faction under this paragraph (c)(4)(iii)(C).
(D) Operating rules. The following rules apply for purposes of
determining numbers of voters and voting control in paragraphs
(c)(4)(iii)(B) and (C) of this section:
(1) Related parties (as defined in Sec. 1.150-1(b)) are treated as
a single person; and
(2) In computing the number of votes necessary to determine the
outcome of the relevant exercise of control, all voters entitled to
vote in an election are assumed to cast all votes to which they are
entitled.
(5) Authority of the Commissioner. In guidance published in the
Internal Revenue Bulletin, the Commissioner may set forth additional
circumstances in which an entity qualifies as a political subdivision
of a State or local governmental unit. See Sec. 601.601(d)(2)(ii) of
this chapter.
(d) Applicability dates--(1) In general. Except as otherwise
provided in paragraphs (d)(2) through (4) of this section, this section
applies to all entities for all purposes of sections 103 and 141
through 150 beginning on the date 90 days after the publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
(2) Applicability date of the definition of political subdivision
for outstanding bonds. For purposes of determining whether outstanding
bonds of an entity are obligations of a political subdivision under
section 103, the definition of political subdivision in paragraph (c)
of this section does not apply to that entity with respect to its
outstanding bonds that are issued before the general applicability date
under paragraph (d)(1) of this section.
(3) Applicability date of the definition of political subdivision
for refunding bonds. For purposes of determining whether refunding
bonds of an entity are obligations of a political subdivision under
section 103, the definition of political subdivision in paragraph (c)
of this section does not apply to that entity with respect to its
refunding bonds that are issued on or after the general applicability
date under paragraph (d)(1) of this section to refund bonds with
respect to which paragraph (c) of this section otherwise does not
apply, provided that the weighted average maturity of the refunding
bonds is no longer than the remaining weighted average maturity of the
refunded bonds.
(4) Applicability date of the definition of political subdivision
for existing entities. For existing entities that are created or
organized before March 24, 2016, the definition of political
subdivision in paragraph (c) of this section does not apply for any
purpose of sections 103 and 141 to 150 during the three-year period
beginning on the
[[Page 8874]]
general applicability date under paragraph (d)(1) of this section.
(5) Elective application of definition of political subdivision. An
issuer may choose to apply the definition of political subdivision in
paragraph (c) of this section to an issue of bonds in circumstances in
which that section otherwise would not apply to that issue under
paragraph (d)(2) or (3) of this section, provided that choice is
applied consistently to the issue. An entity may choose to apply the
definition of political subdivision in paragraph (c) of this section to
an entity in circumstances in which that section otherwise would not
apply to that entity under paragraph (d)(4) of this section, provided
that choice is applied consistently to the entity.
John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-03790 Filed 2-22-16; 8:45 am]
BILLING CODE 4830-01-P