Rev. Rul. 77-164

Advice has been requested whether, under the circumstances described below, a community development authority created by the legislature of a state will qualify as a political subdivision within the meaning of section 1.103-1(b) of the Income Tax Regulations.

M, a community development authority, was created under the laws of state X. Under such laws a private developer can petition a county to establish a community development authority within such county for the purposes of encouraging and overseeing the orderly development of a new community.

Under the laws of state X, M has the power to impose, collect and receive service and user fees and other charges to cover the costs of carrying out the purpose of developing new communities. M may collect fees by three methods, namely, an income charge, a flat fee, or a valuation charge. Such fees are to be used for the construction, operation and maintenance of community buildings, recreation facilities, streets, lighting, and other capital improvements that benefit the property owners.

M is also empowered to enter into agreements with the county in which M is located whereby the county may in its discretion acquire property by eminent domain for M.

The laws of state X provide that M has no power or authority over (1) zoning or subdivision regulation, (2) fire or police protection, or (3) water supply or sewage treatment and disposal unless such services cannot be obtained from existing political subdivisions. M has the power to adopt and enforce rules as to the use of community facilities, but such power does not invalidate the exercise of police power by a municipal corporation. The exercise of police power by a municipal corporation shall prevail in the case of a conflict with powers exercised by M.

Section 1.103-1(b) of the regulations provides, in part, that the term "political subdivision" denotes any division of any state or local governmental unit that is a municipal corporation or that has been delegated the right to exercise part of the sovereign power of the unit.

Three generally acknowledged sovereign powers of states are the power to tax, the power of eminent domain, and the police power. Estate of Alexander J. Shamberg, 3 T.C. 131 (1944), acq., 1945 C.B. 6, aff'd 144 F.2d 998 (2d Cir. 1944), 1945 C.B. 335, cert. denied, 323 U.S. 792 (1944). It is not necessary that all three of these powers be delegated. However, possession of only an insubstantial amount of any or all sovereign powers is not sufficient. All of the facts and circumstances must be taken into consideration, including the public purposes of the entity and its control by a government.

In the instant case, M's power to impose and collect service and user fees is not analogous to the power to tax, which must be clearly delegated by state statute. The service and user fees are not imposed and collected for the purpose of raising revenues to be used for public or governmental purposes but, instead, are for the purpose of benefiting the property owners of one community by increasing the value of their property. The fees are not real property taxes within the meaning of section 164 of the Code. See Rev. Rul. 61-152, 1961-2 C.B. 42, and Rev. Rul. 71-49, 1971-1 C.B. 103, that deal with the definition of taxes.

M is not vested with any power of eminent domain. The authority given to M to enter into agreements with the county that provide for the county acquiring property for M by eminent domain is not analogous to the possession of the power of eminent domain by M.

Further, M does not possess police power. The legislature of state X has given M only a very limited rule making and enforcement power over the use of community facilities and such power is always subordinate to the police power of a municipal corporation in the case of a conflict.

Accordingly, since M does not possess a substantial right to exercise any sovereign powers, M does not qualify as a political subdivision within the meaning of section 1.103-1(b) of the regulations. Therefore, interest paid on obligations issued by M will not be exempt from Federal income tax under section 103(a)(1) of the Code unless such obligations are issued by M on behalf of a state or local governmental unit in accordance with section 1.103-1(b).