Electric Co-Op Comments on Guidance Affecting Nonprofits Linked to Prohibited Transactions

I am writing in response to the request contained in Notice 2007-18 for written comments relating to the interpretation of Section 4965 of the Code by the Tax Increase Prevention and Reconciliation Act of 2005 (the "Act"). As indicated below, Old Dominion Electric Cooperative ("Old Dominion") is particularly concerned by the retroactive nature of the tax imposed by Section 4965 (the "Tax"), and would urge the adoption of rules or regulations that seek to eliminate or at least minimize the impact of the Tax on transactions effected prior to the enactment of Section 4965.

In this regard, Old Dominion is a tax-exempt cooperative under Section 501(c)(12) of the Internal Revenue Code of 1986, as amended (the "Code"), which provides electricity to its members at cost. In order to provide its members with economically priced power, Old Dominion entered into two sale-leaseback transactions in 1996 where a substantial portion of the purchase price was invested in securities the payments thereon which generally matched, in both timing and amount, the rental payments and the fixed price purchase options that were provided under the leases. The remainder of the purchase price received by Old Dominion in connection with these sales was used by Old Dominion in its electric generating business to repurchase debt and lower cost to its members. In 2005, more than nine years after Old Dominion entered into these transactions, the IRS designated these leases ((commonly referred to as sale-in, lease-out transactions (or SILOs)) as "listed transactions" in Notice 2005-13. Because the IRS has designated the two leases that Old Dominion entered into as SILOs, Old Dominion is potentially subject to the Tax imposed under Section 4965 of the Code.

We believe it is extremely unfair to impose the Tax on a transaction that the IRS has not identified as "abusive" at the time the parties entered into the transaction and that, as a result, the Tax should be interpreted in a manner that seeks a to eliminate or ar least minimize the impact of the Tax on transactions that closed prior to the date the Tax was enacted. In this regard, the legislative history to the Act indicates that the purpose of the Tax was "not to collect the taxes imposed, but to provide a strong deterrent that will prevent exempt organizations from participating as accommodation parties in transactions known to be abusive, and to be cautious about entering into transactions that could be considered abusive." Neither of these purposes is accomplished by imposing the Tax on transactions that closed prior to the time the Tax was enacted; the Tax can have no deterrent effect on pre-enactment transactions.

The statement made in the legislative history that the Tax was intended primarily as a deterrent, and not as a revenue raiser, is buttressed by the revenue estimates that were made with respect to the Tax under the Senate and Conference Committee versions of the Tax. Thus, notwithstanding that the Senate version of the Tax was prospective only while the Conference Committee version was retroactive in its application, both versions had virtual identical revenue estimates ascribed to them.¹ As a result, it is clear that the joint conferees did not anticipate that, by making the Tax retroactive, any significant additional revenues would be raised.

Hence, as indicated above, we would urge the Internal Revenue Service to interpret the Tax in a manner that eliminates or at least minimizes the Tax in its application to transactions that closed prior to the date the Tax was enacted -- where the deterrent effect of the Tax is nil. Such an interpretation would be wholly consistent with the legislative history to the Tax.

The simplest and least controversial approach that would "solve" the problem for Old Dominion would be for the Internal Revenue Service to clarify that transactions originally entered into prior to February 28, 2000 are exempted from the Tax. In this regard, the concept of reportable and listed transactions first entered the lexicon with the publication of T.D. 8877, and applied only to transactions entered into after February 28, 2000. While the regulations under Section 6011 have been amended numerous times subsequent to their initial release, they continue to apply only to post-February 28, 2000 transactions. Surely, if the taxable participants in listed transactions are not subject to the various rules and regulations that Congress and the IRS have enacted and promulgated over the past five or so years due to the transactions having been entered into prior to February 28, 2000, a similar exemption should apply under the Act with respect to the tax-exempt participants to these transactions. Hence, we urge the Internal Revenue Service to clarify that the Tax does not apply to transactions originally entered into prior to February 28, 2000.

We note that this interpretation would require the IRS to rework the facts of Example 3 in Notice 2007-17 -- since the Example relates to a transaction that was entered into in 1999. Since the taxable participants to this transaction are exempted from the reportable transaction provisions of the Code (since the transaction was entered into prior to February 28, 2000), we believe the tax-exempt participants to this transaction should also be exempt from the Tax.