IRS may short-circuit Grant County PUD’s plans

Count on the tax man to spoil the party.

Grant County officials have celebrated one economic development bonanza after another in recent weeks. First Microsoft, then Yahoo!, decided to locate huge data storage centers near Quincy, where they will enjoy the advantages of a stout broadband backbone and abundant cheap electricity. Between them, the centers will employ about 100 initially.

Then came REC Silicon, which announced it will build a second, $600 million polysilicon production plant in Moses Lake that will employ as many as 90 workers when it opens in 2008. Again, cheap power was the attraction for an extremely energy intensive factory.

County residents owe these economic blessings to officials who almost a half-century ago had the foresight to build the Priest Rapids and Wanapum dams on the Columbia River. Even with the tremendous loads created by the server farms and silicon plants, as well as the demands of the area’s farm-related industry, those resources have not been tapped out.

But like many utility officials, Grant County Public Utility District commissioners in the later 1990s allowed their heads to be turned by the siren song of telecommunications, which seemed to have unlimited growth potential. The broadband revolution, however, threatened to bypass rural areas, just as electricity transmission grids did until public utility districts and electric cooperatives formed in the 1930s and 1940s to run wire across the countryside.

So the Grant County utility elected to, in a sense, do a rewiring, this time with fiber-optic cable instead of copper. The new network was dubbed ZIPP.

The PUD financed ZIPP construction with a portion of $217.3 million in bonds sold in November 2001. Bond buyers enjoy tax-free interest payments as long as assets purchased with the proceeds are dedicated to not-for-profit uses.

And that’s where the PUD may have come to grief.

Last year, the Internal Revenue Service started raising questions about just how that bond money was used. The agency followed up in April with a “Technical Advice,” a benign term for some very pointed questions. Think audit.

Specifically, Tax Exempt Bond Agent Tom Hupf wants to know how much excess capacity the PUD fiber-optic network has, which private businesses like Internet service providers are using it, and how much. He’s a bit testy about the fact bond proceeds were dedicated to telecom development when the offering statement mentioned the network in but one paragraph.

Hupf figures ZIPP uses 55 percent of the fiber-optic system. If $79.3 million of the bonds were used to build out the system, then ZIPP’s share is $43.8 million, or 20 percent of the bond total. That’s double the 10 percent threshold the IRS allows for third-party, private business activity.

If his position holds up, PUD bondholders could be required to pay taxes on at least a portion of the interest payments. Bad news for them, perhaps worse news for the PUD. Lawsuits have been filed over such matters.

The PUD has failed to convince Hupf his interpretation of private activity is incorrect despite months of discussion.

Hupf also points out, as have PUD critics, that ZIPP has consistently lost money, in part because some of those third parties have big unpaid bills. The district anticipates better days, but negotiations with Yahoo! and Microsoft are not encouraging. Both have the resources to bypass PUD fiber if rates are too high, and the rates officials are discussing are below the PUD’s cost of building the network.

The PUD had until Wednesday to reply to the IRS. But spokeswoman Sarah Morford said Thursday the PUD did not yet have the response, which was prepared by a Houston law firm retained by bond counsel Preston Gates Ellis. The process has delayed public disclosure, she said.

PUD competitors, including for-profit telephone companies, warned the utility its telecom venture was ill-conceived when new technologies like Wi-Fi threatened to leapfrog some broadband applications. They also alleged PUD losses on telecom operations would be covered, if not covered up, with profits from electricity sales. The Washington Legislature passed a law requiring separate sets of books, but regulations are not yet in place.

Grant County PUD has a proud history as a supplier of electricity. Not so, so far, as a telecommunications provider. The IRS and the marketplace may yet vindicate ZIPP. But right now, the venture has become something of a party pooper.