PUD issues response to IRS findings

EPHRATA — The Grant County Public Utility District and the Internal Revenue Service continue to reach different conclusions about whether the district spent too much tax-exempt bond money on "private activities" associated with the Zipp Fiber Optic Network.

The district, in a May 31 response letter from their bond attorney to the IRS, disagreed with unfavorable findings reported by a bond agent in the Seattle office of the nation's tax collection agency.

The IRS agent, in an April 20 report, concluded the district spent more than 10 percent of the funds from a $217 million tax exempt bond issue on the Zipp Network, which the IRS agent determined is a private activity.

"The IRS is looking at the code and making one determination," said Nick Gerde, the district's treasurer-controller. "Our bond counsel is looking at the (federal) treasury regulations and reaching a different conclusion."

If the district issues tax-exempt bonds, the IRS says, there is a 10 percent limitation on how much of the proceeds can be spent on what the agency considers to be private activities.

The IRS first launched its investigation into the district's use of the bond proceeds a year ago. The agency stated, after the conclusion of its initial investigation, that the district spent nearly $80 million of the 2001 bond issue on the utility's fiber optic system — which includes both the Zipp Network and the district's privately used "backbone" fiber optic cables.

The IRS determined the district spent 55 percent of the $80 million on the Zipp Network portion of the fiber optic system, which more than doubled the spending limit of 10 percent of total proceeds from the $217 million tax exempt bond issue.

Twenty-four Internet service providers pay the district for use of the Zipp Network. The ISPs then use the Zipp Network to sell Internet, telephone and point-to-point services to residents and businesses.

The district's Houston-based bond attorney, Gregg Jones, argued in the response letter that the Zipp Network is not a private activity, based on federal treasury regulations and court precedent. Jones said the entire system was constructed by the district for both its own operations and to serve the public.

Still, if the IRS finds the proceeds were spent on private activities, Jones argued, the IRS must also determine if the district made enough money from the private use to pay principal and interest on the bonds.

Gerde said the IRS will not meet the second test.

"We're using electric system money to satisfy the debt because the (fiber optic system) doesn't generate enough net cash flow to satisfy any of the debt service," Gerde said. "We're using non-taxable activities — the electric system — to satisfy a non-taxable bond."

Gerde said the IRS is currently analyzing the district's response letter. It is unclear, he said, what the next step in the process will be.