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Irrigation Districts and the IRS Proposed Rulemaking for Tax-Exempt Bonds

The Internal Revenue Service has proposed changes to the rules by which it determines which entities may issue bonds for which the interest is exempt from federal income taxation. Issuance of tax-exempt bonds is by far the most common means of financing water and wastewater infrastructure in the United States, so the IRS proposal is significant for affected entities. The proposed rule would potentially affect irrigation or similar districts that supply water to a relatively small number of landowners, by excluding such districts from the definition of a “political subdivision.”

Under current IRS rules, an irrigation district or other governmental body is considered to be a political subdivision with the authority to issue tax-exempt bonds, if it is empowered to exercise at least one of the generally recognized sovereign powers. The proposed rule would continue that requirement and add new qualifications that the issuing entity have a governmental purpose and be governmentally controlled.

Under the current and proposed rules [§ 1.103-1(c)(2)], there are three recognized sovereign powers: eminent domain, police power and taxing power. Irrigation districts in the western United States generally possess both the eminent domain and taxing powers, but do not exercise any police powers, which are reserved to the state, counties and cities. Thus, irrigation districts normally qualify as political subdivisions under this requirement.

The proposed rule adds two new qualifications: that the entity issuing bonds have a governmental purpose and be governmentally controlled. Governmental purpose is determined by the purpose for which the entity was created, as set out in its enabling legislation, and the actual conduct of the entity [§ 1.103-1(c)(3)]. Supplying of water for irrigation and other purposes has been widely recognized as a public purpose, and irrigation districts are almost certain to satisfy the governmental purpose requirement under normal circumstances. In fact, the rule includes special districts that provide water, sewer, reclamation or irrigation services as examples of political subdivisions [§ 1.103-1(c)(1)].

The potential difficulty for relatively small irrigation districts arises from the requirement of governmental control [§ 1.103-1(c)(4)]. Under the proposed rule, this requirement is met if the issuing entity is controlled by a state or local governmental unit or an electorate. Control is defined as the power to direct significant actions of the entity and may be determined by three non-exclusive factors: (1) the power to approve or remove a majority of the governing body; (2) the power to elect a majority of the governing body; and (3) the power to approve or direct the significant uses of funds or assets of the entity in advance.

While irrigation districts are generally controlled by electors who own lands within the district, pursuant to normal state election laws, the proposed rule specifically excludes an electorate consisting of a “private faction” [§ 1.103-1(c)(4)(ii)(B)]. A private faction exists if control of the entity is exercised by the votes of an unreasonably small number of private persons. The rule expressly states that a controlling group of voters will always be unreasonably small if it contains three or fewer persons and will never constitute a private faction if it contains more than 10 persons. Groups of between four and 10 persons will be evaluated on the basis of all facts and circumstances. For purposes of counting voters, related parties are treated as a single person. This rule excluding private factions has the potential to impact smaller irrigation districts.

Determining the number of voters in an irrigation district and their degree of control would require a fact-specific analysis. However, there very likely exist small irrigation districts in the western United States that are controlled by a “private faction” as defined in the proposed IRS rule, and therefore would lose the ability to issue tax-exempt bonds. Smaller irrigation districts may include lands owned by a limited number of farmers, especially after application of the “related parties” rule. Compiling the votes of the largest landowners within a district may well result in control of the district by 10 or fewer persons, and the proposed rule should be concerning to those districts and their landowners.

The IRS is accepting comments on the proposed rule until May 23, 2016. The rule would not apply to bonds issued before the effective date of the changes (90 days after publication), and entities that were created prior to the effective date would be granted a three-year reprieve. If you are interested in further information on the proposed rule or how it might affect a particular irrigation district, please feel free to contact me.

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TWDB Opens New Round of SWIFT Financing

The Texas Water Development Board has opened the application period for the next round of SWIFT financing. The application period started yesterday, December 1, 2015, and will remain open through February 5, 2016. The application webpage can be found here.

In the first round of SWIFT financing in 2015, the Board provided funds to just over $1 billion in water projects in Texas, with future commitments for an additional $2.9 billion. The geographic distribution of funds can be seen in the charts below. As is apparent, North Texas was the recipient of the largest share of 2015 funds, while the Houston area was the largest recipient of future commitments and overall funding. The two largest projects were:

2015 Funding v2

Future Funding v2

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Dark Clouds Over California: The Sustainable Groundwater Management Act of 2014

I am excited to release a new white paper regarding the California Sustainable Groundwater Management Act of 2014, entitled Dark Clouds Over California. Please download the white paper and share with your colleagues. For your convenience, the executive summary is published below. Additionally, the Act is spread across three legislative bills, some of which modify each other, making them difficult to read. A compiled version of the Act is available here. Other provisions of the three bills that are not contained within the main body of the Act may be found here.

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New Court Decision Addresses Protest Process for Multiple Water Customer Classes Under Proposition 218

The Fourth District Court of Appeal in California has released a decision regarding the procedural requirements of Proposition 218 as applied to water rates. The case is Morgan v. Imperial Irrigation District, Case Nos. D060146 and D061087, and while the decision is currently unpublished, it is likely that publication will be requested by one or more interested agencies in the near future.

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Collision Course: Proposition 218 and Conservation Water Rates in California

Over the past decade, urban water utilities in California have sought to adopt rate structures that combine, to the extent possible, the goals of financial stability and incentives for efficient water use. This is often accomplished through shifting a relatively larger proportion of costs from fixed service charges to variable commodity rates, dividing commodity rates into multiple tiers with each tier for higher use bearing a higher rate, and disincentivizing the use of urban water supplies for irrigation. A recent California Court of Appeal case, City of Palmdale v. Palmdale Water District, Case No. B224869, tested the intersection of such rates with the primary restriction on public agency water rates, Proposition 218. The result: a moderate collision, with potential for a future pile-up.