NABL Comments on Proposed Rules on Tribal Finance Bonds

Ladies and Gentlemen:

The National Association of Bond Lawyers (NABL) respectfully submits the attached comments in response to the Advance Notice of Proposed Rulemaking in the Federal Register on August 9, 2006 (REG-118788-06), relating to the definition of essential governmental function under Section 7871 and limitation to activities customarily performed by States and local governments.

NABL appreciates the effort of the Department of the Treasury and the Internal Revenue Service in addressing these issues as well as the request for and consideration of NABL's submission.

Primary drafting responsibilities for these comments were assumed by Scott R. Lilienthal, Hogan & Hartson L.L.P. Substantial contributions were made by other NABL members identified on Exhibit I to this letter.

NABL believes that participating in the guidance process supports clarification of and facilitates compliance with the tax law and regulations. Accordingly, NABL members would welcome the opportunity to discuss these recommendations to achieve clarity, certainty and administrability in this area of the law.

If you have any questions, please contact me at 949/725-4237 or through email at clew@sycr.com , Scott Lilienthal at 202/637- 5849 or through email at srlilienthal@hhlaw.com , or Elizabeth Wagner, Director of Governmental Affairs at 202/682-1498 or through email at ewagner@nabl.org .

Thank you again for the opportunity to submit NABL's comments.

The following comments are submitted on behalf of the National Association of Bond Lawyers ("NABL") in response to an Advance Notice of Proposed Rulemaking entitled "Definition of Essential Governmental Function under Section 7871 and Limitation to Activities Customarily Performed by States and Local Governments," published in the Federal Register on Wednesday, August 9, 2006 (the "ANPR"). NABL would welcome the opportunity to discuss these comments with representatives of the Treasury Department and the Internal Revenue Service ("IRS") and to answer any questions that the comments may raise.

NABL was incorporated as an Illinois nonprofit corporation on February 5, 1979, for the purposes of educating its members and others in the law relating to state and municipal bonds and other obligations, providing a forum for the exchange of ideas as to law and practice, improving the state of the art in the field, providing advice and comment at the federal, state and local levels with respect to legislation, regulations, rulings and other actions, or proposals therefor, affecting state and municipal obligations, and providing advice and comment with regard to state and municipal obligations in proceedings before courts and administrative bodies through briefs and memoranda as a friend of the court or agency. NABL currently has approximately 3,000 members.

II. BACKGROUND

Section 7871(a)(4) of the Internal Revenue Code of 1986, as amended (the "Code") provides that an Indian tribal government is to be treated as a State "subject to subsection (c), for purposes of section 103 (relating to State and local bonds)." Section 7871(c)(1) of the Code provides that "section 103(a) shall apply to any obligation (not described in paragraph (2)) issued by an Indian tribal government (or subdivision thereof) only if such obligation is part of an issue substantially all of the proceeds of which are to be used in the exercise of any essential governmental function." Section 7871(e) of the Code further provides that "[f]or purposes of this section, the term 'essential governmental function' shall not include any function which is not customarily performed by State and local governments with general taxing powers." The Indian Tribal Government Tax Status Act, Title II of Pub.L.No. 97-473, enacted in 1982, (the "1982 Act") added Section 7871 to the Code, and the Revenue Act of 1987, Pub.L.No.100-203 (the "1987 Act"), added Sections 7871(c)(3) and (e) to the Code.

The ANPR describes certain parts of the legislative history of Sections 7871(c) and 7871(e) of the Code, and provides that, as a result of an increasing number of questions being raised by taxpayers about the application of Section 7871(e), the Treasury Department and the IRS are seeking public comment in advance of issuing proposed regulations on the subject. The ANPR further provides:

NABL believes that regulations under Section 7871 should provide the clearest guidance possible under the circumstances in determining whether a particular activity is an "essential governmental function" and is "customarily performed by States and local governments with general taxing powers." Also important, the guidance provided in the regulations should be flexible to deal with currently developing and future governmental customs while providing sufficient comfort to allow unqualified opinions to be delivered with respect to Indian tribal government debt. NABL believes that the best way to further these goals is to provide safe harbors for determining when an activity is "customary." However, NABL recommends that the Treasury Department and the IRS take care neither to narrow excessively the scope of these safe harbors nor to sanction an enforcement practice that would, in effect, treat the safe harbors as statements of black letter law -- either approach would frustrate Congressional intent to treat tribes as sovereign entities¹ and to allow Indian tribal governments to issue tax-exempt debt for functions customarily performed by non-tribal governments.

III. COMMENTS ON PROPOSED STANDARD

As noted above, the ANPR provides that the Treasury Department and the IRS anticipate that the proposed regulations will provide that an activity will be considered an essential governmental function that is customarily performed by State and local governments if: (i) there are numerous State and local governments with general taxing powers that have been conducting the activity and financing it with tax-exempt governmental bonds (the "Numerical Test"), (ii) State and local governments with general taxing powers have been conducting the activity and financing it with tax-exempt governmental bonds for many years (the "Time Test"), and (iii) the activity is not a commercial or industrial activity (the "No Commercial or Industrial Activity Test"). NABL's comments with respect to each of these three elements are set forth separately below, as well as comments on the requirement in the Numerical Test and the Time Test that the activity be of a type that is customarily financed with tax-exempt governmental bonds. NABL also has included recommendations regarding the treatment of governmental facilities that may provide indirect benefits with respect to facilities used in non-essential governmental activities.

In addition, NABL recommends that the Treasury Department and the IRS take into account the practical difficulties that Indian tribal governments and their counsel face in attempting to determine the actual prevalence of a particular activity among non-tribal governments. NABL believes that databases adequate to allow tribes, or the IRS, to determine the actual prevalence of many types of activities are unlikely to exist. A case in point, the U.S. Government Accountability Office (the "GAO") was recently asked to compile numerical data on eight specified types of facilities financed, constructed, and operated by State and local governments. In its report, the GAO stated: "We did an extensive review of possible data sources and did not find comprehensive, reliable sources of the number of facilities" (emphasis added). U.S. Government Accountability Office, Federal Tax Policy: Information on Selected Capital Facilities Related to the Essential Governmental Function Test at 2 (2006) (the "2006 GAO Report"). Despite all of the resources available to it, the GAO had difficulty obtaining data on the prevalence of various State and local government activities. Accordingly, NABL recommends that the Treasury Department and the IRS be flexible in providing rules regarding the amount of data that Indian tribal governments should be required to compile in order to establish that an activity is customarily performed by State and local governments.

In determining whether an activity is customary or is performed only in "isolated instances," (see the House report for the 1987 Act, H.R. Rep. No. 100-391, at 1139 (1987) (the "1987 House Report")), the Treasury Department and the IRS should also take into account the fact that the customs of States and local governments differ by region. For instance, in certain parts of the country, governmental electric and water utilities are the norm; in others, such governmental utilities do not exist. In certain regions of the country, the use of governmentally-owned and operated snow removal equipment is widespread, while such activities would be non-existent in States with warmer climates. In some rural areas, fire fighting is the responsibility of volunteer fire companies, not governments. Because of this great diversity of activities that are customarily performed by different State and local governments, NABL recommends that the Treasury Department and the IRS not adopt rules requiring that a large proportion of State and local governments perform an activity in order for it to be considered customary.

To provide a reasonable degree of certainty in determining whether an activity is customary, NABL recommends that the Numerical Test be clarified through the adoption of safe harbors, combined with a general facts and circumstances test. For example, NABL believes that a reasonable safe harbor under the Numerical Test would be one under which an activity would be considered customary if the activity is performed by a specified percentage of States. For purposes of this safe harbor, a "State" should include departments, authorities, instrumentalities, and other agencies of a State. Given the extremely large number of local governments, however, NABL believes that such a percentage test would not be appropriate as the exclusive safe harbor with respect to activities that are generally performed by local governments, agencies, instrumentalities, and authorities rather than (or in addition to) States. Accordingly, NABL recommends that the Treasury Department and the IRS consider adopting a second safe harbor for activities generally performed by local government entities. For example, NABL believes that a reasonable safe harbor in this regard would provide that an activity is considered customary if the activity is performed by a specified number of State or local government units (including their departments, agencies, instrumentalities, and authorities). NABL emphasizes that, in determining the specific levels at which to set these safe harbors, the Treasury Department and the IRS should take into account the factors described above, including the limited sources of data on State and local government activities, as well as the regional variations in customary governmental activities.

Finally, consistent with other guidance under the tax-exempt bond provisions of the Code that utilize safe harbors (see, e.g., Treas. Reg. § 1.141-3(b)(4) and Rev. Proc. 97-13 dealing with management contracts under the private activity bond tests), NABL recommends that an Indian tribal government not meeting a safe harbor be permitted to establish that a particular function is customary based on all of the facts and circumstances. For example, an Indian tribal government might be able to establish that a particular function is so prevalent within the State in which the Indian tribal government is located that it should be considered customary, notwithstanding the fact that none of the safe harbors under the Numerical Test are met.

NABL is aware that issues may arise concerning whether a function performed by an Indian tribal government with respect to a bond financed facility is sufficiently similar to an activity performed by State and local governments that the non-tribal government activity should be counted when applying the Numerical Test. For example, the fact that State and local governments customarily operate gift shops in their museums or in their local visitors' centers would not mean that the operation of any retail facility represents the exercise of an essential governmental function. NABL acknowledges that there must be a reasonable correlation between the type of Indian tribal government facility being financed and the type of State and local government facilities to which the tribal facility is being compared. In light of the difficulties in obtaining reliable data as described above, however, NABL recommends that the Treasury Department and the IRS adopt rules that provide Indian tribal governments with significant flexibility in making this determination.

Nothing in the statutory language suggests that non-tribal governments must have been engaged in an activity "for many years" in order for the activity to be an essential governmental function customarily performed by States and local governments under Sections 7871(c)(1) or 7871(e) of the Code. The words "traditional" and "customary" are not synonymous. Even the 1987 House Report, on which the ANPR relies for much of its approach, describes the notion of "custom" in relation to number only, not with a temporal reference. It contrasts activities that non-tribal governments "customarily" undertake with activities that occur in only "isolated instances." Moreover, the common meaning of the term "customarily" does not support the inclusion of a Time Test. For example, the American Heritage Dictionary (4^th Ed. 2000) defines "customarily" as "[c]ommonly practiced, used or encountered; usual; common."

NABL's view is supported by the IRS in Field Service Advice 200247012 (August 12, 2002), in which Chief Counsel stated that "the inquiry is the degree of prevalence of the function within those jurisdictions where the function is generally performed" (emphasis added), with no reference whatsoever to how long the activity has been prevalent in such jurisdictions. Accordingly, NABL believes that Indian tribal governments should be able to use tax- exempt financing to finance activities that have recently become customary among non-tribal governments, i.e., if there are significant numbers of circumstances (more than "isolated instances") in which non-tribal governments engage in those activities.

Authority under Section 115 of the Code clearly recognizes that activities which comprise "essential governmental functions" will change over time. While NABL recognizes that the legislative history to Section 7871 of the Code can be interpreted as indicating an intention that the standard under Section 7871 be somewhat narrower than the standard under Section 115 of the Code, there is nothing to indicate that, in enacting the provisions of Section 7871(e) of the Code, Congress was concerned with Indian tribal governments using tax-exempt bonds to finance activities that had recently become prevalent among non-tribal governments. Moreover, the rationale expressed in the authority under Section 115 of the Code is equally apt with respect to determinations under Section 7871 of the Code. Regarding this rationale, the Supreme Court has stated that

If there are significant numbers of instances in which non-tribal governments engage in an activity, the fact that most or all of them are relatively recent should not affect the determination of whether the activity is customary. Particularly in this age of rapidly changing technology, the tax policy basis for restricting the ability of Indian tribal governments to finance activities that have recently become customary among non-tribal governments is not evident. Under such a test, tribal governments presumably would have been prohibited from financing new computer technology until some arbitrary number of years after it had become commonly used by non-tribal governments. Only recently have State and local governments begun to own and operate high-speed internet networks to serve remote communities, but NABL believes that whether this function has become customary among non-tribal governments should be based solely on its prevalence.

Based on the foregoing, NABL recommends that the Time Test be excluded from the proposed regulations as not being supported by the statute or legislative history, and as unnecessarily restricting the ability of Indian tribal governments to utilize innovations that have been widely adopted by State and local governments.

In addition, whether a particular governmental function is customarily financed with tax-exempt bonds will often vary from jurisdiction to jurisdiction; for example, State laws may limit the ability of some governments to finance equipment with bonds, and other governments with available alternative resources (e.g., tax revenues, special assessments) may elect to finance infrastructure with sources of funds other than tax-exempt bonds. The fact that some jurisdictions have historically chosen to finance a particular governmental function using current tax revenues (or some other source) rather than by issuing tax-exempt bonds in no way makes that function less "essential" or "customary." Accordingly, NABL recommends that the requirement in both the Time Test and the Numerical Test that the comparable activities of State and local governments be financed with tax-exempt governmental bonds be excluded from the proposed regulations.

The ANPR cites language in the 1987 House Report implying that in order for non-tribal government activities to be considered customary they must also have been customarily financed with tax-exempt bonds. However, House Conference Report No. 100-495 (the "1987 Conference Report"), which significantly modified the original House Bill for the 1987 Act, omitted reference to a tax-exempt bond financing requirement. The 1987 Conference Report also excluded references to a tax-exempt bond financing requirement from its summary of the House Bill and the 1987 House Report. Thus, it is not entirely clear that the language in the 1987 House Report provides a reliable indication of Congressional intent with respect to the finally enacted provision.²

In order for the No Industrial or Commercial Activity Test to be consistent with the statutory language of Sections 7871(c) and 7871(e) of the Code, it would be necessary to conclude that State and local governments with general taxing powers do not customarily engage in commercial or industrial activities, which clearly is not the case. Non-tribal governments long have provided a large variety of goods and services on a fee-for-service basis; recreation, transportation, parking, health care, social services, correctional services, housing, water, electricity, gas, fire protection, public safety, sanitation, convention facilities, and telecommunications are all provided by non-tribal governments, as well as by non-profit and for-profit entities. The 2006 GAO Report provides data clearly showing that State and local governments frequently engage in activities that most would consider commercial in nature (and that they finance such activities with tax-exempt bonds).

A common example might be as follows. The members of an Indian tribe have been served for many years by a municipally-owned electric utility. Due to the remote location of the Indian tribal community, electric service has been unreliable and expensive. The Indian tribal government plans to build and operate a new electric generation, transmission and distribution system to serve the Indian tribal community that will be funded by tax-exempt bonds. Owning and operating an electrical utility is certainly an activity that is commonly performed by State and local governments, but an electrical utility would also appear to be both a commercial and industrial activity. Accordingly, under the No Industrial or Commercial Activity Test the Indian tribal government presumably would be prohibited from financing the improvements with tax-exempt bonds, a result that would be clearly contrary to the intention of Section 7871(e) of the Code to permit Indian tribal governments to issue tax-exempt bonds to finance activities customarily performed by State and local governments.

The ANPR indicates that the No Industrial or Commercial Activity Test is derived from legislative history to the 1982 Act and to the 1987 Act. NABL questions the relevance of this legislative history to the current statutory language, particularly in light of major changes that occurred over time to the language of the various Indian tribal bond legislative proposals.

The language quoted by the ANPR from Senate Report 97-646 (the "1982 Senate Report") itself was derived from committee reports on prior Indian tribal bond legislative proposals that were introduced in 1975 (H.R. 8989, 94^th Cong., 1^st Sess. (1975)) and again in 1977 (H.R. 4089, 95^th Cong. 1^st Sess. (1977)). These bills proposed to allow Indian tribes to issue tax- exempt bonds like States. Both bills specifically included language denying tax-exempt treatment if the bonds financed "any commercial or industrial activity." House Report 95-843, relating to H.R. 4089, accurately described that bill as providing that "in general an Indian tribal government or subdivision will not be able to use tax-exempt bonds to finance its own commercial or industrial activities."

S. 1298, introduced in 1981, retained the general outlines of the 1975 and 1977 proposals, except that it eliminated any mention of "commercial or industrial activities" and substituted, in its place, a requirement that substantially all of the proceeds of such an obligation be used "in the exercise of any essential governmental function or for a public utility." The 1982 Senate Report quoted in the ANPR, however, simply borrowed large sections of language from House Report 95-843 (relating to the 1977 proposal) verbatim, including the language relating to "commercial or industrial activities," despite the fact that S. 1298 specifically deleted the "commercial or industrial" language that appeared in the 1977 and 1975 proposed tribal legislation. Thus, it appears that authors of the 1982 Senate Report simply borrowed this language from prior legislative history without modifying it to reflect actual changes to the bill language.

The ANPR also quotes language from the legislative history to the 1987 Act in support of the No Industrial or Commercial Activity Test. Specifically, the ANPR includes the following quote from the 1987 House Report:

NABL notes that the quoted sentence is offered as an example of activities that the author of the 1987 House Report believed were not customarily performed by non-tribal governments, and is not offered as an additional principle of exclusion. Moreover, the 1987 Conference Report, which significantly modified the original House Bill for the 1987 Act, omitted any reference to commercial or industrial activities, and also excluded it from its summary of the House Bill and the 1987 House Report. It has been held that a conference committee report constitutes "the most reliable evidence of congressional intent because it 'represents the final statement of the terms agreed to by both houses.'" Northwest Forest Resource Council v. Glickman, 82 F.3d 825, 835 (9th Cir. 1996) (quoting Dept. of Health & Welfare v. Block, 784 F.2d 895, 901 (9th Cir. 1986)). In this case, the House version of the Section 7871(e) language was added to H.R. 3545, the House budget bill. The Senate did not offer a counterpart to this provision. In fact, several Senators had introduced legislation that would have enlarged the bonding authority of Indian tribal governments by permitting the issuance of tribal private activity bonds.³ The 1987 Conference Report thus appears to represent a compromise position of a House and Senate that held different views about the need for, and extent of, the new provision. Thus, it is not entirely clear that the 1987 House Report provides a reliable indication of Congressional intent with respect to the finally enacted provision, which makes no reference to commercial or industrial activities.

In addition, the 1987 Conference Report specifically provides evidence that Congress did not intend the enactment of Section 7871(e) of the Code to constitute a blanket prohibition on Indian tribal governments issuing tax-exempt bonds for commercial or industrial activities. As noted above, the 1987 Act added Section 7871(c)(3) of the Code, which created an exception to the general rules on tribal financings for private activity bonds issued to finance manufacturing facilities meeting certain requirements. In summarizing the House Bill, the 1987 Conference Report stated: "The House Bill clarifies that for Indian tribal governments an 'essential governmental function' does not include any function which is not customarily performed by States and local governments with general taxing powers." 1987 Conference Report at 1012. In discussing this provision, the 1987 Conference Committee further provided as follows:

Based on the foregoing, NABL recommends that the blanket exclusion of the No Industrial or Commercial Activity Test be excluded from the proposed regulations. NABL believes that the Numerical Test, as modified pursuant to the recommendations described above, would adequately restrict the ability of Indian tribal governments to utilize tax-exempt bonds to finance industrial or commercial activities that are not customarily performed by State and local governments. NABL believes that the No Industrial or Commercial Activity Test is not clearly supported by the statutory language, and would be contrary to Congressional intent to allow Indian tribal governments to issue tax-exempt bonds for functions customarily performed by non-tribal governments.⁴

If, notwithstanding NABL's concerns raised above, the Treasury Department and the IRS decide to propose some form of the No Industrial or Commercial Activity Test, NABL believes that, at a minimum, the Treasury Department and the IRS should include a safe harbor for facilities that are located on Indian tribal lands and predominantly serve or benefit Indian tribal members. NABL believes that allowing such facilities would not raise the concerns expressed in the legislative history about financing off-reservation industrial or commercial facilities.

The IRS has faced a similar issue under Section 141 of the Code, in providing rules for determining whether facilities will be considered used in a private trade or business for purposes of the private activity bond tests, where the facilities provide a benefit to the private trade or business. The IRS spent several years developing these rules under Section 141, issuing proposed regulations, considering a very large number of public comments, and ultimately issuing final regulations. NABL believes that the IRS has developed a clear and workable standard under Section 141 with respect to these types of facilities, and NABL recommends that a similar standard be adopted for purposes of Section 7871 of the Code.

Under Treas. Reg. § 1.141-3(c), property available for use by the general public will be considered used in a private trade or business only if there is an arrangement that conveys "special legal entitlements" for beneficial use of the property by such private trade or business, such as priority rights or other preferential benefits with respect to the use of the property. NABL recommends that this standard be adopted for purposes of Section 7871 of the Code by treating any non-essential government activity of an Indian tribal government as if it were a private trade or business, and treating any other facilities that are available to the general public as also being used in the non-essential governmental function only if there is an arrangement that conveys special legal entitlements for beneficial use of the property for the non-essential governmental function. In other words, facilities available for use by the general public, such as a public road, or a police station or fire station, or sewage or water treatment plant, would be treated as not being an essential governmental function only if a non-essential government activity (e.g., a casino) possessed "special legal entitlements" with respect to such facilities. For example, if the casino had special priority rights to utilize a certain amount of the output of the water treatment plant, the plant would not be considered an essential governmental function. NABL believes that the tax policy considerations under Sections 141 and 7871 of the Code are similar on this issue, i.e., permitting tax-exempt financing for facilities serving the public except where some non-qualifying activity (private trade or business under Section 141 or non-essential governmental function activity under Section 7871) is given some special rights with respect to the financed property. NABL notes that the IRS recently applied a similar approach in Private Letter Ruling 200648024 (August 4, 2006).

IV. CONCLUSION

NABL commends the Treasury Department and the IRS for their efforts to provide much needed guidance in this area. Again, NABL believes that regulations under Section 7871 of the Code should provide the clearest guidance possible under the circumstances in determining whether a particular activity is an "essential governmental function" and is "customarily performed by States and local governments with general taxing powers." NABL further believes, however, that the ANPR raises new questions, adding uncertainty to an already difficult area of the law. By providing the foregoing recommendations, NABL's goal is to assist the Treasury Department and the IRS in developing clear and practical guidance that will enable Indian tribal governments to fully utilize the benefit that Congress intended to convey in permitting them to issue tax-exempt bonds, while at the same time providing the IRS with administrable rules that will enable it to fairly and efficiently enforce the tax laws.

                           EXHIBIT I

² NABL notes the long-standing principal of statutory interpretation that if statutory language is clear and unambiguous, then it is inappropriate to look to legislative history for a contrary interpretation. See International Brotherhood of Electrical Workers, Local Union 474 v. NLRB, 814 F.2d 697, 699- 700 (D.C.Cir. 1987).

³ Senator McCain introduced the bill on March 17, 1987 on behalf of himself and Senators Evans, Inouye, Burdick, Simpson and DeConcini. Id.; See also John J. Doran, "Congressional Committees Consider Bill to Let Indian Tribes Sell Tax Free IDBs," The Bond Buyer, May 20, 1987, at 6.) Moreover, a bipartisan group of twenty-two senators had written Senate Finance Committee Chairman Bentsen to express their opposition to the House provision. (John J. Doran, "22 Senators Urge Bentsen to Oppose Legislation to Curb Indian Bond Power," The Bond Buyer, Dec. 14, 1987, at 6.)

⁴ In this regard, NABL is troubled by the analysis contained in recently released Tech. Adv. Memo. 200704019 (Oct. 24, 2006), implying that even if any activity is sufficiently prevalent and longstanding among non-tribal governments to be considered customary, such activity may not be financed by an Indian tribal government with tax-exempt bonds if the activity is "commercial."