Attorney Seeks Withdrawal of Proposed Tribal Finance Bond Rules

Dear Mr. Korb:

We are writing on behalf of the Agua Caliente Band of Cahuilla Indians, a federally recognized Indian tribal government (referred to hereinafter as the "Band"). After nineteen years of waiting for any formal guidance under Sections 7871(c) and (e) of the Internal Revenue Code of 1986, as amended (the "Code") from Treasury and the Internal Revenue Service (the "Service"), the Band appreciates finally having the opportunity to comment on the proposed definition of "essential governmental function" detailed in the Service's August 9, 2006, Advanced Notice of Proposed Rulemaking REG-118788-06 (the "Notice").

The Notice states that the Service anticipates proposing rules, in a notice of proposed rulemaking, regarding the definition of an essential governmental function under Code section 7871(c) and the limitation of that term to activities customarily performed by State and local governments for purposes of Code section 7871(e). The Notice proposes the following requirements for an activity to be considered an "essential governmental function that is customarily performed by State and local governments":

Unfortunately, these additional requirements are (A) inconsistent with the statutory language and ignore the application of identical language used elsewhere in the Code; (B) contrary to the legislative history (examined as a whole rather than relying upon isolated statements) and the rules of applying legislative history; (C) contrary to longstanding interpretations of that language by the courts and the Service, and Federal policy toward Indian tribes; and (D) inconsistent with the empirical data regarding the activities that State and local governments with general taxing power are conducting, as reflected in the recently released GAO Report on this subject . . Most strikingly, while the Notice professes to implement Congressional intent, it ignores Congress' clear expression of what constitutes an "essential government function," as set forth in section 906 of the Pension Protection Act of 2006, Pub. L. 109-280 ("PPA"), which was passed by both houses of Congress one week before the Notice was issued (and signed into law by President Bush a week after its issuance).

For the reasons summarized above and described in more detail below, the Notice, and the standards in it, should be withdrawn and regulations should be proposed that implement the statute and true Congressional intent to permit tribes to finance with tax-exempt bonds the broad range of activities commonly engaged in by state and local governments, including activities that promote economic development. Moreover, in light of the 19-year delay in commencing the process of issuing regulations, any regulations should be prospective in effect only.

I. The proposals in the Notice are inconsistent with the statutory language and ignore the application of the identical language used elsewhere in the Code.

The statutory meaning of an "essential governmental function," as used in section 7871(c), is unambiguous. At the time that section was adopted, the phrase "essential governmental function" was used in one other place in the Code -- section 115. The rules of statutory construction demand that a term used in two places in the Code be interpreted consistently.¹ As discussed in Part II below, after initial uncertainty, the meaning of that phrase had been well developed and accepted by both the courts and the Service prior to the enactment of section 7871. Since Congress imported into Code section 7871 the same phrase used in section 115, the Service should not propose interpreting them differently absent clear legislative intent for a different meaning.

Any doubt regarding this approach of Congress was eliminated in the recently enacted section 906(a)(1) of the PPA, which amended the term "governmental plan" for purposes of Section 414(d), to include:

The sole justification provided in the Notice for inserting a "commercial or industrial" test for interpreting the phrase "essential governmental function" in Code section 7871 relies on a selective reading of the legislative history to discern Congressional intent. The legislation merely added the "customarily performed by State or local governments" restriction in place of any restriction on commercial activities. While we believe the Notice's application of the legislative history is incorrect for the reasons discussed below in Part III, we must emphasize that Congress also has stated emphatically in the PPA that the Code does not impose these additional requirements.

Accordingly, based on the specific language of the Code section being interpreted by the proposed regulations, the need to interpret the same term consistently, the rejection of the House Report language by the 1987 Conference Report, and the fact that Congress reiterated its intent in enacting section 906 of the PPA, the Service must abandon its proposed requirement that an activity not be commercial or industrial in nature in order to qualify as an essential governmental function.

The Notice proposes that an activity must be performed by "numerous" State or local governments in order to be considered customarily performed. Having suggested a "frequency" standard and pointed to the dictionary definition, we nonetheless remain concerned whether it might grant too much discretion to IRS field agents without further guidance by way of examples. For example, when addressing this issue in FSA 200247012 (Aug. 12, 2002), the IRS Chief Counsel's National Office recommended using this standard, within the relevant universe of governmental entities that reasonably could be expected to be interested in such activities, and advised that the existence of several thousand municipal golf courses strongly suggested that golf courses were a customary function of state and local governments. IRS Tax-Exempt Bond Field Operations nonetheless rejected that advice from its Chief Counsel's National Office, claiming that it had received contrary advice from IRS local counsel and that the advice of local counsel controls.³

Perhaps a better test would be based less on specific activities and more on the broad categories of functions performed by State or local governments and how similar the scope of the activities performed by Indian tribal governments are to those performed by State and local governments. For example, "functions" could include classes of functions, such as healthcare, welfare, housing, education, recreation, police power, public works, economic development and tourist development. These classes would permit some innovation, as long as the activity falls within the general powers customarily performed by State and local governments. As discussed in Part IV below, such a test is also consistent with the meaning of essential governmental functions, and the federal policy of protecting Indian tribes, and supports tribes' efforts at economic development for their tribal members.

The statute merely requires that the activity be "customarily performed." Congress did not mandate in the statute or suggest in the legislative history that State or local governments must have conducted the activities for any specific period.⁵ In fact, such a standard would be counter to the statute. Technology changes constantly, as do the activities performed by governments. For example, many local governments are beginning to install (or are considering installing) wireless networks throughout their jurisdictions. Over a relatively short period of years, this could (and may already have) become an activity that would satisfy any common sense meaning of what is customarily performed. However, since that activity is relatively new (because the technology has just been developed), it would not satisfy the proposed requirement that the activity be conducted "for many years". Similarly, new security measures may be implemented by State or local governments. If such activities (or technologies) had not been around in the past, they also would not satisfy the proposed "for many years" test if a tribal government wanted to finance the infrastructure improvements for the security of tribal members with tax-exempt financing. This requirement must be re-examined. It goes beyond the statutory language and inappropriately locks Indian tribes into long waiting periods when Congress has stated its intent to improve the lot of Indian tribes and their members.⁶

This situation is identical. The Notice is attempting to read words into the Code that do not appear in the statute, and are not supported by the legislative history. Any such attempt will be reversed by the courts and should be withdrawn now.

II. The proposals in the Notice are contrary to longstanding interpretations of the "essential governmental function" test by the courts and the Service

Both the Supreme Court and the Service have long abandoned attempting to impose restrictions on what constitutes an essential governmental function for State or local governments, which has been imported into section 115 and its predecessor provisions. For example, after years of trying to distinguish between the proprietary and governmental functions of government, the Supreme Court concluded that the distinction between "governmental" and "proprietary" functions of State and local governments was "untenable" and "must be abandoned." New York v. United States, 326 U.S. 572 (1946).⁷ In doing so, the Court rejected the concept that the governmental functions engaged in by the States (for which they were immune from federal taxation) were limited to those engaged in by the States in 1787. In Reeves, Inc. v. Stake, 447 U.S. 429, 443 (1980), the United States Supreme Court further quoted from New York v. United States, stating:

III. The reliance on the legislative history to support the proposals in the Notice is inappropriate

The Notice improperly relies upon a selective collection of statements in the legislative history to support its attempts to extend the statute to prevent Indian tribes from utilizing tax-exempt financing when State and local governments customarily perform the same activities. This reliance is misplaced for several reasons. First, legislative history cannot expand upon unambiguous statutory language. Second, to the extent the legislative history provides guidance, the conference report controls over preliminary committee reports. Third, the reasons for legislative action are not the same as the explanation of the statute. The final reason that reliance on statements in a preliminary legislative report is misplaced is that the statutory language finally approved by both houses of Congress frequently represents a compromise between the House and the Senate and covers a smaller universe of transactions than was originally intended by either house. All of these factors are present here.

In the instant case, the statutory standard of "essential governmental function" is well defined. It must be construed consistently with the same term as construed by the Supreme Court in New York v. United States, used in Code section 115, and applied by the Service in Rev. Rul. 77-261. Moreover, the PPA eliminated any argument that the term was ambiguous, and the legislative history could be used to impose an additional restriction on commercial or industrial activities.

Of most relevance here, however, is that any ambiguity in the Senate Report was resolved by Conference Report No. 97-984 (2d. Sess. 1982). First, the bill that emerged from conference was very different from the Senate bill. Accordingly, the Conference Report must be controlling since it describes the enacted statutory provision. Second, the Conference Report described the Senate bill as permitting interest on bonds other than industrial development bonds to be exempt if used for an essential governmental function, and did not include the commerciality restriction.⁹ Although the Conference Report gave examples of certain activities that were essential governmental functions -- "such as schools, streets and sewers", there is no indication that it intended for this list to be exclusive.

The same issue arose with respect to the enactment of Code section 7871(e), adding the "customarily performed" test in 1987. In 1987, it was the House of Representatives that originated the legislation, with the Senate having no comparable provision. The statutory language remained unchanged throughout the process. The House Report criticized the temporary regulations issued under Code section 7871(c) for permitting financing of "off-reservation enterprises," suggesting its real concerns were with off-reservation commercial activities and not with governmental activities on reservations.¹⁰ We recognize that although the House Report repeated that the activities merely be "customarily performed" by State or local governments, it also stated that the "issuance of bonds to finance commercial or industrial facilities . . . which bonds technically may not be private activity bonds is not included within the scope of the essential governmental function exception."

In contrast, however, the Conference Report¹¹ contained no such restriction. The conference agreement included the language found in section 7871(e), and also added section 7871(c)(3) -- permitting the issuance by tribes of industrial development bonds.¹² The Conference Report simply states that a tribal facility "satisfies the "essential governmental function' standard" if it "is comparable to facilities that are customarily acquired or constructed and operated by State or local governments."¹³ It summarized the Temporary Treasury Regulations under section 7871(c) as defining "an 'essential governmental function' to include any project for which Federal assistance to Indian tribes may be provided, thereby including some commercial and industrial activities not generally conducted by States and local governments with general taxing powers." It described the House bill as clarifying that for Indian tribal governments, an essential governmental function did not include a function not customarily performed by State or local governments.

Finally, footnote 5 of the Conference Report -- describing lodges owned and operated by States as an essential governmental function -- unmistakably clarifies that Congress did not intend to impose a commerciality test. It concludes,

With respect to the proposal in the Notice that the comparable activities must be debt financed by the State or local governments, the sole support we could find came from an isolated statement in the House Report. Yet, the statute and the Conference Report contained no such statement. Thus, the only conclusion is that the Conference Committee considered the proposal suggested by the House, rejected it, and did not impose any such requirement. Thus, read in its entirety, the legislative history does not support a prohibition on commercial or industrial activities being financed by Indian tribes with tax-exempt bonds if those activities are comparable to those performed by State or local governments. It also does not support requiring that the comparable activity be debt-financed by the State or local government. Attempting to justify the proposals in the Notice through the use of the limited quotations from reports describing preliminary bills that were not enacted by Congress is inappropriate and would not be sustained by any court.

IV. The proposals in the Notice are contrary to Federal policy toward Indian tribes

Indian tribes are sovereign governments. The Service and its representatives, unfortunately, have repeatedly failed to respect that sovereignty. One of the purposes of the Indian Tribal Government Tax Status Act of 1982 (as amended in 1987) was to respect that status and clarify that Indian tribes were generally to be treated similar to State and local governments -- especially as regards the issuance of bonds, provided that the activities were comparable to those customarily performed by State or local governments. The statutes and conference reports imposed no additional restriction as regards financing commercial or industrial activities, other than the customarily performed test added in 1987.

Moreover, we believe that the statute and, to the extent necessary, the legislative history, unambiguously reject imposing any requirement that tax-exempt debt-financed activities of Indian tribes may not be commercial if they otherwise constitute an essential governmental function customarily performed by State or local governments. If there is any ambiguity on this issue, however, any such ambiguity must be construed to protect the ability of Indian tribes to issue such bonds. Competing canons of statutory construction may come into play -- balancing the concept that Congress intends its statutes to benefit Indian tribes due to the trust relationship and encouraging tribal independence, against the canon that exemptions from tax must be clearly expressed. Chickasaw Nation v. United States, 534 U.S. 84 (2001); Squire v. Capoeman, 351 U.S. 1 (1956). For example, in Lazore v. Commissioner, 11 F.3d 1180 (3d Cir. 1993), the court rejected the claim of exemption from federal income tax by members of the Mohawk tribe. The court initially noted that a general statute that applies to all persons applies to Indians and their property. It then balanced this principle against the taxpayers' ability to rely on a treaty that predated the imposition of the federal income tax, concluding that the exemption must be supported by the text of a specific treaty. Accordingly, under the Lazore case, Indian treaties should be liberally construed to favor a treaty-based tax exemption for Indians only if the treaty contains language that can reasonably be construed to confer income exemptions. A similar rule should apply when balancing the statutory language -- if the statutory language can be read to support the exemption, the exemption should apply.¹⁵

Another justification supporting the ability of Indian tribes to issue tax-exempt debt for governmental activities that may also have a commercial element is that it supports economic development, including tourist development. Every state does both. The Supreme Court recently emphasized that

In the instant case, there is little balancing that is necessary. To begin with, the Senate Report for the Indian Tribal Government Tax Status Act of 1982 stated that among the reasons for the change in law were to enable Indian tribes to "assist their people by stimulating their tribal economies and by providing governmental services."¹⁶ It provided for both and not simply one or the other. In the statutory language -- both as originally enacted and later amended -- Congress clearly stated its intent regarding the ability of Indian tribes to issue tax-exempt bonds for "essential governmental functions customarily performed by State or local governments." Congress knew how both the Supreme Court and the Service interpreted that phrase "essential governmental function" at the time it adopted the provisions, and recently reiterated its position in the PPA. The additional restrictions proposed in the Notice obtain their sole support from the preliminary reports on early versions of bills that were later the subject of additional compromises, and described in their respective conference reports without these restrictions. They ignore the stated purpose of the underlying legislation, as included in the 1982 Senate Report. Thus, eliminating these unnecessary restrictions is not only consistent with the canons favoring protection of Indian tribes, but is not in conflict with the canon narrowly construing exemptions because Congress has expressly permitted such exemptions without the additional restrictions contained in the Notice.

V. The proposals in the Notice also are inconsistent with data regarding the activities that State and local governments with general taxing powers customarily perform.

The proposal in the Notice that activities cannot constitute both essential governmental functions customarily performed by State or local governments and also be commercial is unjustified not only as a matter of law and Congressional intent, but also as a factual matter. For example, in a field service advice, the IRS National Office discussed whether construction and operation of a golf course is an "essential governmental function" under Section 7871(e). Although it voiced concerns over the "commercial" nature of the golf course, the National Office acknowledged "it is probable that a court, faced with this fairly common activity of state and local governments, and taking into account the interpretative standard accorded Tribal governments, would conclude that the Golf Course meets the statutory standard for an essential governmental function."¹⁷

In September 2006, the Government Accountability Office issued a report surveying certain facilities of State and local governments related to the essential governmental function test.¹⁸ It found that State and local governments provided a wide range of financial support and engaged in the following types of facilities in large numbers -- rental housing, road infrastructure, parking garages and parking lots, community recreation facilities (civic centers and convention centers), golf courses, conference centers, and hotel and tourist accommodations. The GAO Report also identified some state-owned gaming support facilities, but the GAO staff was unable to determine the numbers of such facilities. Moreover, in each case, the GAO identified bond financing used to varying degrees for all of these activities. Thus, it is clear that the State and local governments do "customarily perform" these commercial activities as part of their essential governmental functions.

With respect to the debt financing of such activities by State and local governments, the GAO Report expressed frustration about its inability to obtain reliable data regarding which projects were financed with tax-exempt debt.¹⁹ States frequently debt-finance a large portion of their capital projects. They often issue general obligation bonds supported by tax revenues, although they sometimes use revenue bonds with dedicated sources of repayments. They frequently use related entities for various business reasons or to avoid certain restrictions on their issuance. Indian tribes do not generally have the revenue generating capacity possessed by State and local governments. Their best opportunity is to use revenue streams from their tourist and other economic development activities that are customarily performed by State and local governments and respected as governmental functions. Thus, the lack of useful data on what is debt financed and how they are financed and how to allocate general obligation financing among different projects makes the imposition of this requirement not only contrary to the statute, but an unfair limitation on tax-exempt debt financing by tribes unless the Service also provides a meaningful system to determine what in fact is debt-financed by the State and local governments and some mechanism or standard to determine when an activity is "customarily performed."

VI. Suggestions for the proposed regulations.

2. The Service should also withdraw its proposal that the comparable activity conducted by a State or local government was also debt-financed with tax-exempt bonds.

3. The Service should also withdraw the language requiring an activity to have been carried on "for many years." This might justifiably be one of the considerations in determining whether an activity has been "customarily performed" by State or local governments, but it should not be required if numerous governmental entities have engaged, or currently engage in the activity.

4. The interpretation of "customarily" as meaning "numerous" could be retained, perhaps with some guidance as to how many is considered numerous. Any guidance should be based on the relevant universe of governmental entities that reasonably could be expected to be interested in such activities.²⁰

2. Activities included in the GAO Report should be included in the list of examples of permitted activities.

3. Consideration should be given to the use of broader categories of functions (e.g., as discussed in Part I.C., above) along with a requirement that the activity be conducted on tribal land.

4. An expedited process for rulings or other guidance is needed to permit Indian tribes to issue tax-exempt bonds promptly following the issuance of proposed and temporary regulations. For too long, Indian tribes have been forced to pay a significant risk premium to issue tax-exempt bonds due to the absence of guidance and/or the expectation of the market that any such bonds could be tied up in examinations for years. This risk premium, on top of the credit issues already facing Indian tribes, makes it very expensive and impractical to issue such debt because purchasers require greater comfort on the tax status of the bonds.

VII. Conclusion

We thank you for finally initiating the rulemaking process in this important area. We hope that you are able to proceed expeditiously and fairly in promulgating regulations. We stand ready to assist you and answer any additional questions you may have with respect to our comments.

²E.g., The American Heritage Dictionary 341 (4th ed. 2000) (commonly practiced, used or encountered; usual; common); Webster's Ninth New Collegiate Dictionary 318 (1991) (the adverbial form of "customary," which means 'commonly practiced, used, or observed'"; Black's Law Dictionary 385 (6th ed. 1990) (usually, habitually, according to the customs; general practice or usual order of things; regularly).

³ A. McConnell, "TEB's Toughening Trend," Bond Buyer (Dec. 27, 2005),

⁴ "What might have been viewed in an earlier day as an improvident or even dangerous extension of state activities may today be deemed indispensable." Reeves, Inc. v. Stake, 447 U.S. 429, 443 n. 16 (1980) (quoting dissenting opinion in New York v. United States, 326 U.S. 572, 591 (1946)).

⁵Id.

⁶ We are concerned that the use of the phrase "many years" is intended to mean that only those activities that constituted "traditional" governmental functions engaged in many generations ago may be financed by Indian tribes with tax-exempt bonds. Clearly, the Supreme Court and the Service itself have rejected that position when applied to States and local governments. The proposed regulations also must explicitly reject any such position.

⁷ In New York v. United States, the Court addressed New York's claim of immunity from tax being imposed on its activity of bottling water on grounds that it was engaged in the exercise of a usual, traditional and essential governmental function. The Court concluded that this activity (like alcoholic beverage sales) could be subject to a federal excise tax. However, the Court rejected any distinction based on whether the activity was an essential governmental function or proprietary, noting that "[T]o rest the federal taxing power on what is 'normally' conducted by private enterprise in contradiction to the 'usual' governmental functions is too shifting a basis for determining constitutional power and too entangled in expediency to serve as a dependable legal criterion. The essential nature of the problem cannot be hidden by an attempt to separate manifestations of indivisible governmental powers." 326 U.S. at 580.

⁸Northwest Forest Resource Council v. Glickman, 82 F.3d 825, 835 (9^th Cir. 1996) (quoting Dept. of Health & Welfare v. Block, 784 F.2d 895, 901 (9^th Cir. 1986)). See also Disabled in Action of Metropolitan of New York v. Hammons, 202 F.3d 110, 124 (2d Cir. 2000) (comparing the various types of available legislative history and stating that "[b]ecause a conference committee report represents the final statement of terms agreed to by both houses, next to the statute itself, it is the most persuasive evidence of Congressional intent.").

⁹ Conference Report at 16-17.

¹⁰ H.R. Rep. 100-391 at 1139 (1987).

¹¹ H.R. Rep. No. 100-495 (1987).

¹² We are unaware of any bond issuances under this provision, which is virtually unworkable, absent useful guidance from the Service.

¹³ H.R Rep. No. 100-495 at 1012 n. 5.

¹⁴id.

¹⁵ The canons of construction applicable in Indian law are rooted in the unique trust relationship between the United States and the Indians, a consideration that applies equally to treaty and non-treaty matters. Oneida County v. Oneida Indian Nation, 470 U.S. 226,247 (1985). The Service apparently has rejected the trust relationship in dealing with Indian tribes. Federal law has been construed generously toward Indian tribes in order to comport with "traditional notions of sovereignty and with the federal policy of encouraging tribal independence." Merrion v. Jicarilla Apache Tribe, 455 U.S. 130, 152, (1982) (quoting White Mountain Apache Tribe v. Bracker, 448 U.S. 136, 143-44, (1980)). Where ambiguity remains after consulting the statutory text, context, purpose, and legislative history, the appropriate resolution is the one that favors the Indian tribe. See Artichoke Joe's Cal. Grand Casino v. Norton, 353 F.3d 712, 731 (9th Cir. 2003).

¹⁶ S. Rep. 97-646 (2d. Sess. 1982) at 11, 1983-1 C.B. 514, 518. The Senate clearly recognized the problems facing the uncertain tax status of Indian tribes and their problems with economic development, and sought to correct them:

With the power to tax, the power of eminent domain, and police powers, Indian tribal governments have responsibilities and needs quite similar to those of State and local governments.

Increasingly, Indian tribal governments have sought funds with which they could assist their people by stimulating their tribal economies and by providing governmental services.

The committee has concluded that, in order to facilitate these efforts of Indian tribal governments that exercise such sovereign powers, it is appropriate to provide these governments with a status under the Internal Revenue Code similar to what is now provided for the States . . . .

¹⁷ FSA 200247012, supra. We understand that despite the advice of counsel, the Service refused to concede this case, thereby reinforcing the perception that the Service shows no respect for the special status of Indian tribes and the application of Federal tax law to them. A. McConnell, "Bond Lawyers: IRS Out of Order on Tribal Financings," Bond Buyer (November 2, 2005). It certainly appears that the Service went out of its way to assist the State and City of New York in creating legal fictions to allow the use of debt-financing to build stadiums for the New York Yankees and Mets (Priv. Ltr. Rul. 200640001 [Jul 11, 2006] and Priv. Ltr. Rul. 200641002 [Jul. 19, 2006]), but then went out of its way in the other direction to create barriers for Indian tribes to use tax-exempt financing for tourist facilities on their reservations. See A. McConnell, "Attorneys: PILOTS, Tribal Rulings Inconsistent," Bond Buyer (August 10, 2006).

¹⁸ GAO-06-1082, "Report to the Ranking Minority member of the Senate Finance Committee; Federal Tax Policy -- Information on Selected Capital Facilities Related to the Essential Governmental Function Test" (September 2006 (the "GAO Report"), www.gao.gov/cgi-bin/getrpt?GAO-06-1082.

¹⁹ "[T]he information we provide is limited because state and local governments are not required to report specific numbers of facilities financed with tax-exempt bonds or the funding details for each facility. According to bond finance experts, states frequently finance with a single bond several capital projects in broad categories that could be similar to the eight types of facilities in your request." Id. at 2.

²⁰ This concept was discussed as relevant in FSA 200247012.