Final Regs Define 'Sewage Facility' for Tax-Exempt Bond Purposes

 [4830-01-u]

 ACTION: Final Regulations.

 SUMMARY: This document contains final regulations on the definition of sewage facilities. These regulations reflect changes to the law made by the Tax Reform Act of 1986 and affect taxpayers who seek tax-exempt bond financing for sewage facilities.

 DATES: These regulations are effective December 23, 1994.

 For dates of applicability of these regulations, see 1.142(a)(5)-1(e).

 FOR FURTHER INFORMATION CONTACT: Joanne E. Johnson at (202) 622-3110 (not a toll-free number).

 SUPPLEMENTARY INFORMATION:

BACKGROUND

This document amends 26 CFR part 1 to provide rules under section 142(a)(5) of the Internal Revenue Code of 1986 (Code) allowing tax-exempt, private activity bond financing for sewage facilities.

 On May 3, 1994, the IRS published in the Federal Register a notice of proposed rulemaking (59 FR 22773 [PS-34-93]) defining sewage facilities under section 142(a)(5). A number of written comments were received concerning the proposed regulations, and a public hearing was held on July 26, 1994. After consideration of all the written and oral comments, the proposed regulations are adopted as revised by this Treasury decision.

EXPLANATION OF PROVISIONS

IN GENERAL

 The final regulations define a sewage facility for purposes of section 142(a)(5) of the Code. Many commentators, including the United States Environmental Protection Agency, recommended expanding the definition of a sewage facility to include property for advanced or tertiary treatment. Commentators suggested that additional treatment of these types is often necessary due to the condition of the receiving water, rather than the characteristics of the influent wastewater. In response to this comment, the final regulations provide that qualifying sewage facilities include certain property used for advanced or tertiary treatment.

 Several commentators suggested modifying or eliminating the biochemical oxygen demand (BOD) limit contained in the proposed regulations because they believe that property that performs a sewage treatment function should qualify regardless of the BOD level of the wastewater. Other commentators maintained that the BOD limit undermines current water conservation policy and may be subject to manipulation. Clarification was also requested regarding the particular point in the sewage treatment process that the BOD limit must be measured.

 The BOD limit has been retained in the final regulations because it reasonably approximates the upper limit of the average daily raw wasteload concentration for most publicly owned treatment works and generally distinguishes between water pollution control and sewage treatment. However, the BOD limit has been modified in response to the comments received. The BOD limit does not apply if the failure to satisfy the limit results from the implementation of federal, state, or local water conservation measures. The final regulations also clarify that determination of the BOD limit is measured at the time the influent enters the sewage facility. Finally, an anti-abuse rule has been added to prevent distortions of BOD levels designed to circumvent the BOD limit.

 While some commentators requested that tax-exempt, private activity bond financing be permitted for pretreatment property, the final regulations retain the rule contained in the proposed regulations that excluded pretreatment property from the definition of a sewage facility. The IRS and Treasury have concluded that pretreatment property is more in the nature of water pollution control property, which is ineligible for tax- exempt, private activity bond financing.

 In response to comments, the final regulations clarify that sewage disinfection property is functionally related and subordinate to property qualifying for tax-exempt, private activity bond financing as a sewage facility. Furthermore, some commentators advised that it was not clear under the proposed regulations whether septage treatment property qualified as a sewage facility. The final regulations clarify that, since sewage sludge, as defined under 40 CFR 122.2, includes septage, septage treatment property qualifies as a sewage facility. In addition, under the final regulations septage treatment property is not subject to the BOD limit.

 Finally, in light of potential future technological advances in wastewater treatment, the final regulations provide that the Commissioner may determine that facilities using technologically advanced or innovative processes qualify as sewage facilities if these facilities perform functions that are consistent with the definition of sewage facilities contained in the final regulations.

EFFECTIVE DATE

 The final regulations apply to issues of bonds issued after February 22, 1995. A transitional rule is provided for certain refundings.

SPECIAL ANALYSES

 It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is Joanne E. Johnson, Office of Assistant Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.

Treasury Decision 8576

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.142(a)(5)-1 is added to read as follows: 1.142(a)(5)-1 Exempt facility bonds: Sewage facilities.

(a) IN GENERAL. Under section 103(a), a private activity bond is a tax-exempt bond only if it is a qualified bond. A qualified bond includes an exempt facility bond, defined as any bond issued as part of an issue 95 percent or more of the net proceeds of which are used to provide a facility specified in section 142. One type of facility specified in section 142(a) is a sewage facility. This section defines the term sewage facility for purposes of section 142(a).

(b) DEFINITIONS -- (1) SEWAGE FACILITY DEFINED. A sewage facility is property --

(i) Except as provided in paragraphs (b)(2) and (d) of this section, used for the secondary treatment of wastewater; however, for property treating wastewater reasonably expected to have an average daily raw wasteload concentration of biochemical oxygen demand (BOD) that exceeds 350 milligrams per liter as oxygen (measured at the time the influent enters the facility) (the BOD limit), this paragraph (b)(1)(i) applies only to the extent the treatment is for wastewater having an average daily raw wasteload concentration of BOD that does not exceed the BOD limit;

(ii) Used for the preliminary and/or primary treatment of wastewater but only to the extent used in connection with secondary treatment (without regard to the BOD limit described in paragraph (b)(1)(i) of this section);

(iii) Used for the advanced or tertiary treatment of wastewater but only to the extent used in connection with and after secondary treatment;

(iv) Used for the collection, storage, use, processing, or final disposal of--

(A) Wastewater, which property is necessary for such preliminary, primary, secondary, advanced, or tertiary treatment; or

(B) Sewage sludge removed during such preliminary, primary, secondary, advanced, or tertiary treatment (without regard to the BOD limit described in paragraph (b)(1)(i) of this section);

(v) Used for the treatment, collection, storage, use, processing, or final disposal of septage (without regard to the BOD limit described in paragraph (b)(1)(i) of this section); and

(vi) Functionally related and subordinate to property described in this paragraph (b)(1), such as sewage disinfection property.

(2) SPECIAL RULES AND EXCEPTIONS -- (i) EXCEPTION TO BOD LIMIT. A facility treating wastewater with an average daily raw wasteload concentration of BOD exceeding the BOD limit will not fail to qualify as a sewage facility described in paragraph (b)(1) of this section to the extent that the failure to satisfy the BOD limit results from the implementation of a federal, state, or local water conservation program (for example, a program designed to promote water use efficiency that results in BOD concentrations beyond the BOD limit).

(ii) ANTI-ABUSE RULE FOR BOD LIMIT. A facility does not satisfy the BOD limit if there is any intentional manipulation of the BOD level to circumvent the BOD limit (for example, increasing the volume of water in the wastewater before the influent enters the facility with the intention of reducing the BOD level).

(iii) AUTHORITY OF COMMISSIONER. In appropriate cases upon application to the Commissioner, the Commissioner may determine that facilities employing technologically advanced or innovative treatment processes qualify as sewage facilities if it is demonstrated that these facilities perform functions that are consistent with the definition of sewage facilities described in paragraph (b)(1) of this section.

(3) OTHER APPLICABLE DEFINITIONS -- (i) ADVANCED OR TERTIARY TREATMENT means the treatment of wastewater after secondary treatment. Advanced or tertiary treatment ranges from biological treatment extensions to physical-chemical separation techniques such as denitrification, ammonia stripping, carbon absorption, and chemical precipitation.

(ii) NONCONVENTIONAL POLLUTANTS are any pollutants that are not listed in 40 CFR 401.15, 401.16, or app. A to part 423.

(iii) PRELIMINARY TREATMENT means treatment that removes large extraneous matter from incoming wastewater and renders the incoming wastewater more amenable to subsequent treatment and handling.

(iv) PRETREATMENT means a process that preconditions wastewater to neutralize or remove toxic, priority, or nonconventional pollutants that could adversely affect sewers or inhibit a preliminary, primary, secondary, advanced, or tertiary treatment operation.

(v) PRIMARY TREATMENT means treatment that removes material that floats or will settle, usually by screens or settling tanks.

(vi) PRIORITY POLLUTANTS are those pollutants listed in app. A to 40 CFR part 423.

(vii) SECONDARY TREATMENT means the stage in sewage treatment in which a bacterial process (or an equivalent process) consumes the organic parts of wastes, usually by trickling filters or an activated sludge process.

(viii) SEWAGE SLUDGE is defined in 40 CFR 122.2 and includes septage.

(ix) TOXIC POLLUTANTS are those pollutants listed in 40 CFR 401.15.

(c) OTHER PROPERTY NOT INCLUDED IN THE DEFINITION OF A SEWAGE FACILITY. Property other than property described in paragraph (b)(1) of this section is not a sewage facility. Thus, for example, property is not a sewage facility, or functionally related and subordinate property, if the property is used for pretreatment of wastewater (whether or not this treatment is necessary to perform preliminary, primary, secondary, advanced, or tertiary treatment), or the related collection, storage, use, processing, or final disposal of the wastewater. In addition, property used to treat, process, or use wastewater subsequent to the time the wastewater can be discharged into navigable waters, as defined in 33 U.S.C. 1362, is not a sewage facility.

(d) ALLOCATION OF COSTS. In the case of property that has both a use described in paragraph (b)(1) of this section (a sewage treatment function) and a use other than sewage treatment, only the portion of the cost of the property allocable to the sewage treatment function is taken into account as an expenditure to provide sewage facilities. The portion of the cost of property allocable to the sewage treatment function is determined by allocating the cost of that property between the property's sewage treatment function and any other uses by any method which, based on all the facts and circumstances, reasonably reflects a separation of costs for each use of the property.

(e) EFFECTIVE DATE -- (1) IN GENERAL. This section applies to issues of bonds issued after [INSERT DATE 60 DAYS AFTER PUBLICATION OF THESE REGULATIONS IN THE FEDERAL REGISTER].

(2) REFUNDINGS. In the case of a refunding bond issued to refund a bond to which this section does not apply, the issuer need not apply this section to that refunding bond. This paragraph (e)(2) applies only if the weighted average maturity of the refunding bonds, as described in section 147(b), is not greater than the remaining weighted average maturity of the refunded bonds.