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TRIBAL BUSINESS STRUCTURE HANDBOOK 2008 Edition By Karen J. Atkinson, President, Tribal Strategies, Inc. and Kathleen M. Nilles, Partner, Holland & Knight LLP A Tribal Self-Governance Project of the Tulalip Tribes Sponsored and Published by The Office of the Assistant Secretary – Indian Affairs Credit: This Handbook was funded by an economic development grant awarded by the U.S. Department of the Interior’s Office of Indian Energy and Economic Development (IEED) to the Tulalip Tribes of Washington for the development of a tribal biogas plant in Snohomish County. Disclaimer: Nothing in this Handbook should be construed or relied upon as legal advice. Instead, this Handbook is intended to serve as general guidance and an introduction to business structure from which better informed requests for legal advice and tax advice can be formulated. Published by: The Office of the Assistant Secretary – Indian Affairs U.S. Department of Interior Foreword by the Sponsor and Publisher The Office of Indian Energy and Economic Development (IEED) was established in 2006. IEED is responsible for expanding reservation business opportunities and Indian employment with emphasis on the development of energy and mineral resources on Indian trust lands; providing oversight of initiatives designed to assist tribes in developing stronger reservation and/or tribal economies; developing policies and procedures for job placement and training under the Indian Employment Training and Related Services Demonstration Act of 1992 (P.L. 102-477), as amended; and providing credit under the Indian Financing Act of 1974. The office formulates policies and procedures to surmount barriers to reservation economic growth and assists tribes in developing economic infrastructure, augmenting business knowledge, increasing jobs, businesses, and capital investment, and developing energy and mineral resources. IEED helps tribes develop their energy and mineral resources on trust lands and manages special economic programs, grants, projects and initiatives to advance reservation economies. In addition, the office is responsible for implementing P.L. 102-477, as amended; the Indian Financing Act of 1974; and Title V of the Energy Policy Act of 2005. The office consists of the Division of Energy and Mineral Development, the Division of Economic Development, the Division of Workforce Development, the Division of Capital Investment, and the Division of Indian Energy Resource Agreements. We undertook this project to further our mission of developing economic infrastructure and increasing business knowledge. We think tribal governments will find the Handbook filled with many specifics that will help them and their business managers pinpoint issues for analysis in the quest to select the best business structure. For tribal governments starting to think about launching a business enterprise, the Handbook will become a primary reference. The authors have taken care to streamline the discussions about each of the business structures. This should enable tribal governments to make informed decisions about which structure to discuss with tribal legal counsel and the tribal accountant. For tribal government officials who are unfamiliar with business structures, the Handbook can also impart an understanding of how various Indian business enterprises function by comparison. We hope that this will encourage tribal governments to consult with one another regarding the success tribal businesses have achieved because of (and not in spite of) their structures. There will be a second edition of the Handbook in the next several years. Robert W. Middleton, Ph.D. Director, Office of Indian Energy and Economic Development The Authors Karen J. Atkinson is Mandan, Hidatsa, and Tsimshian and President of Tribal Strategies, Inc. in Washington, D.C. Karen has extensive experience as a legal and policy advisor on federal Indian law and tribal economic development. She has experience in energy planning and development, business consulting for Indian tribal governments, and advising companies seeking to work with tribes. Karen focuses on creating public/private partnerships that increase economic development in tribal communities. She has provided advice on how to form tribal business entities, on how to create tribal business partnerships, and on financing options and tax incentives for projects in Indian Country. Kathleen M. Nilles is a partner with Holland & Knight LLP (resident in its Washington, D.C. office) and a member of the firm's Indian Law practice group. Kathleen has almost twenty years of experience advising tribal governments on tax and corporate issues. In the course of her practice as a tax attorney, she has assisted tribes in structuring numerous types of business entities and has secured IRS rulings and determinations to confirm their tax treatment. Kathleen has also provided legal advice on joint ventures, tax-exempt financing, energy tax incentives, and employment tax issues. She is a member of the Board of Directors of the National Intertribal Tax Alliance. Kathleen gratefully acknowledges the assistance, advice and contributions of her colleagues at Holland & Knight, particularly Telly Meier, Jerry Levine, Allyson Saunders, Brian Guth and Sam Kastner. Table of Contents Page TABLE OF CONTENTS.................................................................................................i I. INTRODUCTION.....................................................................................................I-1 A. W HY CHOOSING A B USINESSSTRUCTURE ISMPORTANT ...................................I-2 B. SUCCESS FACTORS .............................................................................................I-2 C. O VERVIEW OFSTRUCTURES ...............................................................................I-4 D. SUCCESS FACTORS .............................................................................................I-6 II. TRIBAL GOVERNMENT ENTITIES....................................................................II-1 A. U NINCORPORATED AGENCIES, DIVISIONS ANINSTRUMENTALITIES ...............II-1 B. POLITICALS UBDIVISION OT RIBALG OVERNMENT ........................................II-13 III. TRIBAL CORPORATIONS................................................................................ III-1 A. TRIBALLY -CHARTERED C ORPORATIONS ........................................................ III-1 B. SECTION 17 CORPORATION —F EDERAL LAW CORPORATION ........................III-10 IV. STATE LAW ENTITIES..................................................................................... IV-1 A. STATE LAW C ORPORATIONS ........................................................................... IV-1 B. SUBCHAPTER S CORPORATIONS ..................................................................... IV-6 C. STATE-LAW L IMITEDLIABILITYCOMPANIES .................................................. IV-7 D. A DVANTAGES AND DISADVANTAGES OF STATE-LAW B USINESSENTITIES.....IV-10 V. JOINT VENTURE ENTITIES................................................................................V-1 A. LIMITED LIABILITC OMPANIES .......................................................................V-2 B. G ENERAL PARTNERSHIPS AND LIMITEDP ARTNERSHIPS...................................V-3 C. C ONSIDERATIONSC OMMON TO LLC S AND LPS................................................V-4 VI. EVALUATING YOUR OPTIONS...................................................................... VI-1 A. C OMPARISON OF EACH FORM ........................................................................ VI-1 B. K EYF ACTORS TOCONSIDER .......................................................................... VI-4 CHART: STRUCTURES AT A GLANCE APPENDIXA: SOVEREIGN IMMUNITY FACTORS IN RECENT JUDICIAL DECISIONS......................................................................................A-1 APPENDIX B: KEY STEPS TO PROTECT THE CORPORATE VEIL AND TO LIMIT LIABILITY.....................................................................B-1 ENDNOTES i I. INTRODUCTION th The late 20 century brought a new era of federal-tribal relationships and a policy of self- determination to Indian country. Indian Tribes are increasingly asserting control over their land, resources, and governance of their communities. Tribes are involved in a wide range of economic activities from tourism, gaming, energy, agriculture, forestry, manufacturing, federal contracting, and telecommunications. In many parts of the country, Tribes are becoming regional economic and political power houses. They are the largest employer in many counties. Tribal governments and tribal businesses engage in a wide range of business and financial transactions. The unique legal status of tribes is only now beginning to be used by Tribal governments to contribute to their business and economic development efforts. This century marks a new era for tribes using their sovereign status and governmental authority to achieve economic self- sufficiency and cultural preservation. There are still high levels of poverty and unemployment in Indian country and a lack of the basic infrastructure crucial to the building blocks of economic success. There are, however, increasingly more examples of tribes breaking their dependence on federal programs and creating the necessary legal infrastructure to build the foundations for successful economic development. As tribal business transactions become increasingly more sophisticated and involve non- Indian partners, investors, and lenders, there is a need to understand the basic methods for doing business in Indian country. In particular, in the energy industry, Indian tribes are shifting from being passive owners of their energy resources by evaluating ways in which they can own, develop, and produce their resources. Tribes are increasingly looking at ways to develop their resources in a manner that gives them an active ownership interest in the development of the project, often with a non-Indian business partner. There are unique factors that a tribe should consider when deciding how to structure a business transaction or how to partner with a non-Indian business. This Handbook will provide a general guide to the key factors that an Indian tribe should consider when structuring a business or project. It will look at the basic structures available to tribal governments when organizing for economic development activities and will consider whether business formation should occur under tribal, federal or state law. It will also consider the tax consequences of each type of business structure. The Handbook will assist tribal managers in determining which structure will work best to protect tribal assets, preserve tribal sovereignty, and maximize the use of tax and other incentives available for tribal economic development. This guide is general in nature. You should consult legal counsel and accountants to determine the best business structure for your particular circumstances. I-1 A. Why Choosing a Business Structure is Important The choice of business structure will have long-term and far-reaching consequences for a tribal government and tribal business. The business structure you choose will have a major impact on how tribal assets are protected, how tribal sovereignty is preserved, and how potential liability is minimized. Critical decisions regarding the tax status of the business entity and whether or how sovereign immunity is waived must be made early in the decision making process. The choice of business structure may also be determined by the requirements a lender imposes as a financing condition or be determined by a business partner seeking certainty and predictability in the legal framework chosen to organize for economic development. This Handbook will help you to compare and analyze different structures and help determine which is best for you. B. Success Factors In the last decade, a substantial amount of research has been done to determine what impediments exist to creating long term sustainable economic development on Indian reservations and to identify the factors that have lead to significant progress on some reservations. Most tribes are committed to improving the economic welfare of its people and at the same time are concerned that this not be done in a way that diminishes their sovereignty. The Harvard Project on American Indian Economic Development (Harvard Project) has found that a key factor to achieve economic self-determination is to have institutions in place which promote self-governance and to provide a political environment in which investors will feel secure.1 Indian reservations have to compete with other venues to attract economic activities. To be successful, tribes must offer investors the opportunity to earn economic returns commensurate with the returns they might earn elsewhere. Investment dollars have to come from somewhere. Investor risk is raised if there is uncertainty in tax and regulatory policies that apply to on- reservation businesses or transactions. Risk is also raised if there is uncertainty regarding the enforcement of contracts or agreements. Governmental policies requiring preference hiring or policies that change frequently can also raise the risk and costs for investors or business partners. The Harvard Project has identified a number of success factors geared to create a political environment that promotes sustained economic growth by providing a safe environment for investors. Such an environment helps investors--whether they be tribal members or outsiders--to feel secure and willing to put their time, energy and capital into the tribal economy. The first critical factor is for tribes to have a separation and allocation of governmental powers. This can be accomplished through formal or informal governmental structures. The second critical factor is the separation of tribal electoral politics from the day-to-day management of business enterprises. This relates to the direct role that tribal governments often have in development projects. Tribal governments should have a role in strategic decision- making. However, tribal governments should not make the day-to-day business decisions of tribal enterprises. Maintaining this separation can be difficult for tribal officials since enterprises and its assets belong to all tribal members. However, not insulating tribal politics from tribal I-2 businesses can create an uncertain and risky business environment for investors and business partners. Political instability, the possibility of opportunism on the part of tribal officials, and the difficulties in enforcing agreements can discourage investment. This can place tribes at a competitive disadvantage for attracting capital as well as technical and management expertise. Inserting politics into day-to-day business decisions can drain the resources of the entity, and run a tribal enterprise into the ground. This type of governance will result in inefficiencies and loss of productivity that is difficult to absorb in a highly competitive environment. Successful businesses in Indian country are typically insulated and their day-to-day business management is free from political interference. The Harvard Project found that tribally- owned enterprises that are insulated2from political interference are about four times as likely to be profitable as those that are not. The way tribes’ have insulated business from politics has ranged from traditional culture-based separation of power to legal or tribal constitutional limits to the establishment of separate tribal entities and manage businesses. Insulating tribal business entities from political interference is accomplished by establishing a managing board of directors and a corporate charter that is beyond the direct control of tribal council members. Businesses require a stable operating environment while managers need to make decisions in a business environment. The creation of a tribal business development corporation or other business entity separated from tribal government can provide a number of advantages: • Free the tribal council from micro-managing tribal businesses and allow the council to focus on long-term development strategies and goals • Assign responsibility to operate and manage tribal businesses to those who have business skill and knowledge • Provide a buffer between managers and tribal politics • Provide continuity and stability to business management by promoting the development of economic develop3ent and business policies that are less subject to change by electoral politics. This Handbook will describe a variety of options for tribes to consider when structuring tribal businesses in a way that segregates business from politics. Key factors to consider when trying determining the best structure for a particular activity are: Segregate politics from business--Free the tribal council from micro-managing tribal businesses while allowing the council to focus on long-term development strategies and goals. Assign responsibility to operate and manage tribal businesses to those who have business skill and knowledge. Organizational considerations--How the entity is formed, under what law is the entity formed, and who manages the entity. I-3 Sovereign Immunity--Tribes as governmental entities are not subject to suit unless they clearly waive immunity or Congress has waived their immunity. This raises questions regarding the ability of lenders, investors, and business partners to enforce agreements and to protect their investment. Each entity has different sovereign immunity implications that must be considered. Liability--Some business structures effectively shield business owners from liability for the financial obligations and debts of the business. Others do not effectively separate owner obligations from business entity obligations. Tax considerations--Different federal income tax rules apply to different business types. State tax liability frequently depends on whether the business activity is conducted on or off an Indian reservation. Financing--Money for a business comes in two forms: (1) debt--whereby the business borrows and then owes money to others; and (2) equity--where investors provide funding and then own part of the business. Lenders generally do not dictate choice of business entity, but equity investors may specify what business structure you can choose. C. Overview of Structures Tribal governments are distinct political entities in our federal system of government. They have the power of self-government and exercise sovereignty over their members and territory. Their sovereignty pre-dates the Constitution and is derived from the fact that they owned all the land that is now the United States. The U.S. Constitutthn acknowledges the sovereign status of Indian tribes in the Treaty Clause, in the 14 Amendment as "Indians not taxed," and in the Commerce Clause. The sovereign nature of Tribes has been recognized in the Constitution, treaties, court decisions, and the course of dealing with tribes. As sovereign Nations, Indian tribes have powers and capabilities not available to individuals. This Handbook will assist you in evaluating the different forms available for organizing economic development and to begin to take steps to achieve financial and economic independence. When developing a new tribal enterprise, an important consideration is the applicable law and regulations governing its formation and operation. In Indian country, business entities can be formed under tribal law, state law or federal law. Your choice of law and the entity that is chosen will have consequences on issues relating to tax, financing, and sovereign immunity. It will also determine how you can maximize risks and liability. An important consideration for tribes is how to preserve tribal control and to protect tribal assets while providing a business partner or lender with certainty. A tribe, because it is a sovereign nation, can form a governmental entity to perform business functions. This entity can be an instrumentality of tribal government, a political subdivision of the tribe, or an agency or division of the tribe. A tribe can also form a separate business entity formed under federal, tribal, or state law. Below is a brief description of the main business structures. I-4 1. Tribal Government Many tribes conduct business through an economic development arm of the tribe. This is often referred to as in unincorporated instrumentality of the tribe. The business operation is generally overseen by the governing body of the tribe--sometimes by a business committee or a separate board, but they generally do not have a separate legal structure. Therefore, the same privileges and immunities of the tribe can apply to contractual agreements entered into by the tribe and to business instrumentalities of the tribe. Tribes and its business instrumentalities organized as an arm of the tribal government are not taxable entities for purposes of federal income tax. 2. Section 17 Corporations Many tribes conduct their commercial activities through federally4chartered corporations formed under Section 17 of the Indian Reorganization Act (IRA). To form a Section 17 Corporation, a tribe must petition the Secretary of the Interior for issuance of a corporate charter. A Section 17 corporation provides a framework by which a tribe can segregate tribal business assets and liabilities from the assets and liability of tribal governmental assets. It also preserves the integrity of the decision-making process of tribal governmental officials by separating business decisions. The charter defines the powers of the corporation which can include the power to buy and sell real and personal property and to conduct such further powers as may be incidental to the conduct of corporate business. Several courts have held that tribal sovereign immunity applies to the business activities conducted by a Section 17 Corporation; other courts have found a waiver of sovereign immunity in the "sue and be sued" clause of the corporate charter. Tribal corporations formed under Section 17 of the IRA have the same tax status as the tribe and are not subject to federal income taxes for income derived from on or off reservation activities. 3. Tribally Chartered Corporations Some tribes have adopted tribal laws that govern the formation of tribally chartered for- profit corporations. These laws authorize the formation of tribal business entities owned by the tribe. Several courts have held that sovereign immunity applies to activities of a tribally chartered corporation owned by a tribe. The issue of whether tribally charted corporations are subject to federal income taxes for income derived from on-reservation activities is up in the air. The Internal Revenue Service has this issue under consideration and has indicated that it will issue guidance, but has not yet done so. 4. State-law Corporation A corporation is a legal entity that is formed under the laws of the state by filing a certificate of incorporation or articles of incorporation with the jurisdiction in which it is formed. Corporations are owned by shareholders and governed by a Board of Directors elected by the shareholders. Corporations are governed by the terms and conditions contained in its articles of incorporation. The main benefit of a corporation is that shareholders are not personally liable for the debts, obligations, or liabilities of the corporation. Shareholders are liable only for the I-5 amount of their investment in the corporation. This insulates tribal government assets from the liabilities of a tribal corporation. However, a corporation is a separate taxpayer. Income is taxed twice, once at the entity level and again when distributed to shareholders as dividends. A corporation owned by a tribe, but chartered under state law is considered to have a different tax status than the tribe and is likely subject to federal income tax. 5. Limited Liability Company The limited liability company (LLC) is a relatively new form of business entity that rose to prominence in the last ten years. Almost every state has enacted laws permitting the formation of an LLC. LLCs are formed by filing articles of organization with the state in which it is formed. It is a hybrid between a partnership and a corporation. It combines the primary advantage of a partnership--ease of formation and maintenance, and favorable taxation--with the key advantage of a corporation--limited liability protection for its owners. The owners of an LLC are typically called members. Individuals, corporate entities, tribes and tribal entities can be members of an LLC. Most states allow an LLC to have only one member. Like a partnership, its income is only taxed once. The tax attributes are passed down from the entity to its owners in proportion to their ownership interest--known as "pass through tax treatment." Therefore, a tribe’s share of income from a LLC would not be subject to federal income tax. D. Success Factors When choosing a business structure, there are many things a tribe should consider regarding business issues and tribal governmental issues. One of the key factors is how to preserve tribal control while also insulating business decisions from tribal governmental decisions or tribal politics. Another critical factor for tribes is how to preserve tribal assets and limit exposure to business liabilities. Other factors are: how to effectively manage the entity, how to maximize tax benefits, how to minimize financial risks, the location of business operations--on or off the reservation, what assets will be pledged, how the business will be capitalized, which structure enables the preferred method of equity or debt financing, and the requirements of one’s business partner or lender. This Handbook will look at key attributes to consider as you determine the ideal structure for your business. These include: • Organizational considerations • Sovereign immunity • Legal Liability • Federal tax treatment • Financing considerations. As you learn about each entity and evaluate these factors, you will be able to see how these factors all come together to create a business structure which best meets your needs. You I-6 will see which businesses fit best with which entity type. You will have a working knowledge of the impact each of these factors will have on your business. When looked at together, these factors will point to the best entity choice for a particular tribal business enterprise. I-7 II. TRIBAL GOVERNMENT ENTITIES A. Unincorporated Agencies, Divisions and Instrumentalities 1. Description and Examples Tribes are self-governing sovereigns with traditions of self-government that pre- date the Constitution. Accordingly, Tribal governments do not derive their powers or sovereignty from the United States. The sovereignty of tribes is recognized in the Commerce Clause and Treaty Clause of the U.S. Constitution. Tribes, generally exercise powers of self-government that are derived from their status as separate and distinct sovereigns. 5 Tribes exercise inherent rights of self-government including the power to engage in business and commercial activities. Many tribes operate under traditional forms of government, or by adopting constitutions or codes under tribal law allowing them the power to engage in business and commercial activities. 6 In addition, in 1934, Congress enacted the Indian Reorganization Act (IRA) to encourage economic and political self-determination by permitting tribes to organize their tribal governments under constitutions adopted pursuant to Section 16 of the IRA. Tribes had the option to accept or reject the IRA. Tribes that chose to organize their government under Section 16 of the IRA adopted a Tribal Constitution that was reviewed and approved by the Secretary of the Interior. Alaska and Oklahoma tribes were originally excluded from the IRA, but the provisions were later extended7to Alaska Natives and similar provisions were extended to some Oklahoma tribes. Tribal constitutions adopted under Section 16 of the IRA typically established a system of centralized government with a chief executive, usually a Tribal Chairman or President, a legislature, usually a Tribal Council, a Tribal Business Committee, or Board of Directors that was vested with legislative and executive powers, and a weak judiciary. Tribal governments often directly control or participate in business activities through unincorporated instrumentalities of the tribe. These are often referred to as an economic arms of the tribe. These instrumentalities or arms of tribal government are not considered to be distinct legal entities. Examples are tribal casinos, tribal enterprises, and tribal utilities. 2. Organizational Characteristics Formation--Unincorporated instrumentalities of a tribal government are formed under tribal law for commercial purposes and share the same legal characteristics of the tribal government because they are not separate legal entities. A tribe’s constitution and II-1 by-laws or codes may provide tribal governments with the power to create and operate subordinate economic entities. These entities are generally established by tribal 8 resolution or by tribal ordinance. Management--These entities are usually directly controlled by the tribal government and its tribal council to serve as the development arm of the tribe. Sometimes a tribal enterprise may have a board of directors, but it is usually comprised of tribal council members. An unincorporated instrumentality often has a manager in charge of its day-to-day operations. General Characteristics--Tribes have operated ski resorts, farming ventures, cigarette sales and gaming through unincorporated tribal entities. There is no separation of the business entity from the tribal government body and such enterprises do not hold assets or property separately from the tribe. Land and assets used by the unincorporated enterprise are held by the tribal political body and are not specifically conveyed or set aside. In some instances, there are no separate bank accounts, separate directors, or assets.9 The enterprise is wholly-owned by the tribe. The tribal council is typically involved in day-to-day management decisions either directly or indirectly. For example, the Navajo Nation formed the Navajo Forest Products Industries 10 (NFPI) which is wholly-owned and operated by the tribe on the Navajo Reservation. NFPI is an instrumentality or arm of the tribal government. The enterprise manufactures wood products. NFPI conducts day-to-day operations and is supervised by a general manager who is appointed and responsible to a nine-member management board. The board is appointed by the Navajo Tribe’s advisory committee which is ultimately responsible for the operation of the business enterprise. The advisory committee is comprised of the Navajo Tribal Council. Researchers with the Harvard Project have described the unincorporated tribal instrumentality as a Council-Run Model. See adapted diagram below. II-2 The Tribal Instrumentality Model Council Enterprise Board CEO Employees • The Council sits on the Enterprise Board and is involved in day to day management of the business. • The board (if it exists) advises the Council and the CEO about strategy but generally has no power to act on important corporate policy issues. 3. Sovereign Immunity and Liability Issues Sovereign Immunity--As a matter of federal law, judicial relief to enforce contracts or agreements against an Indian tribe in state or federal court is permitted only where Congress has authorized the suit or the tribe has waived its immunity. 12 Sovereign immunity protects the limited and irreplaceable tribal resources from large judgments and safeguards tribal self-governance. The doctrine of sovereign immunity recognizes that a tribe’s sovereign status is directly related to its ability to generate revenues through the regulation of commercial activities on the reservation. The ability to contract impacts a tribe’s fiscal resources by binding or obligating the funds and assets of the tribe. Therefore, courts have found that corporate contractual provisions are economic matters that directly affect a tribe’s right to self-government. From this perspective, a tribal business entity under certain circumstances can be determined to be a tribe’s alter ego and share the same attributes of tribal sovereignty a13the tribe such as sovereign immunity from suit in order to protect tribal assets and property. Indian tribes possess the common-law sovereign immunity from suits similar to that enjoyed by other sovereigns. 14 Tribal enterprises which serve as subordinate economic tribal entities created by an Indian tribe possess attributes of sovereignty such as sovereign immunity15Consequently, they cannot be sued absent a clear waiver of sovereign immunity. Indian tribes are generally immune from suits on contracts that involve governmental or commercial activities on or off a reservation. 16 A business entity that is an instrumentality or arm of the tribe or an unincorporated entity of a tribe II-3 can share the same attributes of the tribe including sovereign immunity from suit. When a tribe establishes an entity to conduct certain activities, the entity is immune from suit if it is functioning as a17arm of the tribe such that its activities are appropriately deemed to be those of the tribe. Courts have rejected attempts to limit sovereign immunity to the governmental activities of a tribe and have found tribes to be immune from suit for business activities if operating as an arm of the tribe. 18 A tribal instrumentality or unincorporated enterprise of a tribal government, however, can not unila19rally act to waive tribal sovereign immunity except in accordance with tribal law. Tribal commercial enterprises cover a broad range of activities that include gaming, smoke shops, convenient stores, business parks and other enterprises. Many courts have found that subordinate economic entities o20the tribe created for commercial purposes share the same immunity as the tribe itself. Tribal sovereign immunity can create uncertainty and risks for would-be investors or business partners. For instance, agreements may not be enforceable where one party (e.g., a tribe or tribal entity) is immune from suit. In many disputes regarding tribal commercial activities, an issue is raised regarding whether a tribe has waived sovereign immunity. An Indian tribe cannot be sued unless there is a clear waiver of sovereign immunity by the tribe itself or a clear abrogation of immunity by an Act of Congress. 21 A tribe may waive immunity by contract or agreement, by tribal ordinance, by resolution, or by its corporate charter. Such waiver must be in accordance with valid tribal law, such as a constitution and by- laws, by tribal code, or other provision which authorizes the waiver and permits tribal officials to execute contracts.2 Tribes have granted limited waivers of sovereign immunity. Waivers can be limited in a number of ways. A waiver can be limited to (1) a specific tribal asset or enterprise revenue stream, (2) a specific type of legal relief sought by performance of the contract and not money damages, (3) a claim limited to the amount borrowed, or (4) a specific enforcement mechanism, such as court or arbitration. The Supreme Court has recently construed an arbitration clause contained in a contract executed by a tribe as constituting a clear waiver of sovereign immunity. 23 In this instance, the tribe entered into a contract that did not contain an express waiver of sovereign immunity or express consent to state court jurisdiction. Rather, the contract contained an arbitration provision in which the tribe agreed to arbitrate claims under the contract, agreed to the governance of state law, and agreed to the enforcement of the arbitrator award in "any court having jurisdiction." The Court concluded that the tribe waived immunity from suit and enforcement of the arbitration award with requisite clarity. When a tribe engages in commercial activities as an unincorporated arm of the tribal government, it will need to address questions regarding tribal sovereign immunity. When a tribe enters into a commercial endeavor it is investing its time, energy, and II-4 resources, and its business partner is doing the same. It is a reasonable business practice for all parties to want to protect their business investments. Tribal sovereign immunity can prevent a lender or business partner from protecting its investment. Whenever a tribe or an unincorporated instrumentality of the tribe enters into a contract or agreement, sovereign immunity is implicated. A lender or business partner will likely seek a method to protect its investment through a limited waiver of sovereign immunity. The decision to waive immunity is a governmental decision. One of the disadvantages of forming a tribal business entity as an unincorporated instrumentality of a tribal government is that the sovereign status of the tribe may impede a tribe’s ability to obtain credit and financing for its business transactions if agreements are not enforceable through judicial action. Also, if a tribe does waive it’s immunity from suit through a tribal instrumentality, it may subject the assets of the tribe to potential liability for the obligations of the tribal instrumentality. Since there is no separate legal entity conducting business, the assets and obligations of the tribe are intermingled with the business. 4. Tax Treatment Tax Treatment--There is no federal statutory provision that exempts Indian tribes from federal income taxation. However, the Internal Revenue Service has concluded that federally recognized tribes and their federally-chartered corporations are not subject to federal income taxes. 24 With respect to tribal governments, the IRS in Revenue Ruling 67-284 based its conclusion on the fact that tribes are political bodies that Congress did not intend to include within the meaning of taxable entities subject to the income tax provisions of the Internal Revenue Code regardless of whether the business activity is inside or outside of Indian-owned lands. With respect to tribal federally-chartered corporations, the IRS takes the view that no taxable entity separate from the tribe exists. Any income earned by a tribe is not subject to federal income tax regardless of whether a tribal business activity is on or off Indian-owned lands. 25 The federal tax treatment of a tribal enterprise will depend on how a business is structured. The IRS has generally treated an unincorporated instrumentality or business operated directly by a federally recognized tribe as not subject to federal income tax, again because it is not considered to be an entity separate from the tribe itself. As a note of caution, there is no per se exemption from federal income taxation when a tribe organizes as an "instrumentality." To be considered a nontaxable entity, the instrumentality must be operating as an arm of the tribe, and not organized as a separate legal entity. In determining whether an entity qualifies as a government instrumentality, the IRS generally looks at the following six factors: 1) whether the organization is used for a governmental purpose and performs a governmental function; 2) whether performance of its function is on behalf of one or more governmental units (e.g., a state, a tribe or political subdivision); II-5 3) whether there are any private interests involved, or whether the governmental unit has the power and interest of an owner; 4) whether control and supervision of the organization is vested in a public authority or authorities; 5) whether express or implied statutory or other authority is necessary for the creation and/or use of the organization, and whether this authority exists; 6) and the degree of fin26cial autonomy of the entity and the source of its operating expenses. If it meets this multi-factor test, an instrumentality will qualify for tax benefits reserved to governmental entities--such as the ability to receive charitable contributions or to issue tax exempt bonds. Recognizing that for some purposes tribal governments have similar qualities to state governments, Congress passed the Indian Tribal Governmen27l Tax Status Act in 1982 to provide similar governmental tax treatment to tribes. The Tribal Governmental Tax Status Act, codified as section 7871 of the Internal Revenue Code, provides that federally recognized tribes are treated like states for purposes of a number of tax benefits, including: • Charitable contributions are tax deductible • Gifts and bequests are deductible • Tax exempt bonding authority • Exemption from certain excise taxes • Treatment as a government under the private foundation excise tax rules. Although Code Section 7871 did not codify the basic tax immunity of tribal governments, the legislative history indicates that Congress was aware of the Internal Revenue Service’s position and did not wish to alter it. 5. Financing Considerations Two major considerations in obtaining credit through conventional lending are: (1) the lenders need to be able to enforce an agreement, and (2) they need to protect their investment in the event of a default. A tribe operating an enterprise as an arm of the tribal government may have difficulty obtaining conventional financing. Ability to enforce agreements--Lenders will be reluctant to provide credit if they are not certain that they can enforce their contract against a tribal enterprise that is an arm of the tribe because, like the tribe, it will be immune from suit. A tribe and lender can address this in a number of ways. The tribe can waive sovereign immunity for a particular transaction. Or, as addressed later in this Handbook, the tribe can form an II-6 entity separate from the tribal governing body that does not have sovereign immunity from suit or which has been vested with limited sovereign immunity. Collateral and Security Interest--In addition to sovereign immunity concerns, a conventional lender will also want collateral or a security interest so that its investment is protected if there is a default or the enterprise is not successful. An enterprise operating as an unincorporated instrumentality of the tribe and its governing body will not have separate assets or property to pledge as collateral. Rather, tribal assets would have to be pledged and there will be no limitation of liability. Loan Guarantee Programs: U.S. Department of the Interior Capital Investment Program. The Department of the Interior, Office of Indian Energy and Economic Development ("IEED") has an "Indian Affairs Loan Guaranty, Insurance, and Interest Subsidy Program" with two key loan programs. The first is a loan guaranty program in which a loan from a lender to a Tribe or an Alaska Native group may be provided a guaranty of up to 90% of a loan if the business activity will contribute to reservation economic development. The IEED does not make direct loans. Loans may be made to finance Indian-owned businesses organized for profit, provided that Indian ownership constitutes at least 51% percent of the business. In 2006, the maximum loan amount that could be guaranteed for tribes is $12 million dollars. Each year Congress determines the limit on the total amount that IEED may guaranty. In 2006, the Office of IEED had $107 million dollars. In recent years, the Office of IEED has exhausted its limit before the end of the fiscal year. In some circumstances, IEED may subsidize the interest rate guaranty under the program by paying the difference between the yield on outstanding obligations of the United States of comparable maturity and the rate the bank is charging the Indian borrower. The second is a new loan insurance program that may provide a more efficient process for tribally-owned firms to obtain loans under the $250,000 amount and at a lower cost than the IEED loan guaranty program. Under the insurance program, a bank that has been certified for the program may issue loans up to $250,000 to tribal firms without obtaining IEED approval. The IEED fees for this program are 1% less than the guaranteed loan program. Under this program, IEED will insure the lesser of 90% of the loan or 15% of the total dollar amount of the bank's loan portfolio issued under the insurance program. U.S. Department of Agriculture ("USDA") Business & Industry ("B&I") Loan Guarantee Program. The Business & Industry Loan Guarantee Program is intended to improve, develop, or finance business, industry, and employment, to improve economic conditions in rural communities. The guarantee fee charged, which may be passed on to the borrower, is two percent of the original loan amount. The fee may be reduced to one percent if certain criteria are met. Eligible borrowers include Indian tribes 28 or federally recognized groups. II-7 Loan proceeds can be used for machinery and equipment, buildings and real estate, working capital, and certain refinancing. Generally, the maximum amount available to a borrower is $25 million; however, the maximum amount for rural cooperatives processing value-added commodities is $40 million. The USDA will guarantee up to 90 percent of the amount of the loan under $2 million, 80 percent of a loan between $2 million and $5 million, 70 percent of a loan over $5 million, and 60 percent of a loan over $10 million. Small Business Administration ("SBA") 7(a) Program. The SBA 7(a) Program provides co29ercial loan guarantees to American small businesses for general business purposes. Loan proceeds may be used for working capital, machinery and equipment, furniture and fixtures, land and buildings, leasehold improvements, and certain refinancing. The loan term is up to 10 years for working capital, and up to 25 years for fixed assets. 7(a) loans are only available on a guaranty basis. This means they are provided by lenders who choose to structure their own loans by SBA's requirements and who apply and receive a guaranty from SBA on a portion of this loan. The SBA does not fully guaranty 7(a) loans. The lender and SBA share the risk that a borrower will not be able to repay the loan in full. The guaranty is a guaranty against payment default. Tribally-owned businesses may be eligible to receive loan guarantees if they meet other SBA requirements regarding size, nature of the business, use of proceeds, and lack of available credit elsewhere. SBA regulations provide that businesses deriving more than one-third of their gross annual revenue from "legal gambling activities" are ineligible to for SBA loans. 30 Tax-exempt Bonding. Section 103 of the Tribal Governmental Tax Status Act permits tribal governments to issue tax exempt bonds. When a tribe issues tax exempt bonds, the investors in such bonds are able to earn interest free of tax. Thus, all other factors being equal, such bonds should yield lower interest rates than taxable debt. Bond financing (whether taxable or tax-exempt) also has the advantage of allowing the borrower to spread repayment of principal and interest over a longer period. Only Indian tribal governments and their political subdivisions are qualified issuers of tax exempt debt. Furthermore, the IRS has ruled privately that certain entities that qualify as "integral parts" of the tribe may also issue such debt.1 In addition, the IRS has ruled that Indian entities qualifying as an "instrumentality" of one or more government units may use tax exempt financing, and such use will not constitute a 32 "private business" use. In addition to meeting these tests, which focus on the identity of the person issuing the bonds (or on whose behalf the bonds are issued), all tribal tax-exempt debt must finance facilities that serve an "essential governmental function." Section 7871 does not define an essential government function, but Section 7871 states that it does not include functions not customarily performed by state or local governments. The II-8 interpretation of the "essential governmental function" test has spawned a number of controversies between the IRS and tribes. Recently, the IRS announced a proposed rulemaking to bring more clarity to this area of the law. Tax Credit Financing. The Energy Policy Act of 2005 includes authority for nonprofit utilities and governmental entities, including tribal governments, to issue tax credit bonds to finance the cost of renewable energy projects--known as Clean Renewable Energy Bonds ("CREBs"). These entities may issue a total of up to $800 million in tax-credit bonds between January 2006 and the end of December 2007 to finance solar, wind, biomass, landfill gas, geothermal, and small irrigation power facilities that generate electricity. No more than $500 million of the CREBs can be allocated for projects of government entities. The project must be owned by a governmental entity or non-profit entity. Initial applications for allocation of these bonds were due April 26, 2006. H.R. 6408, the Tax Relief and Health Care Act of 2006, recently extended and expanded the availability of CREBs. Section 202 of the bill authorizes an additional $400 million of CREBs and extends the authority to issue such bonds through the December 31, 2008. The bill is expected to be signed into law by President Bush. Assuming that the bill is enacted, it is expected that there will be a new round of applications that eligible issuers may submit. Project Financing/Non-Recourse Debt Financing. Project financing involves non-recourse financing of the development and construction of a particular project in which a lender looks primarily to the revenues expected to be generated from the project for the repayment of its loan and to the assets of the project as collateral for its loan rather than the general credit of the project owner or developer. Capital-intensive projects requiring large investment of funds such as power plants, pipelines, and power generation facilities, are increasingly funded using project finance. Developers of these projects are frequently not sufficiently creditworthy to obtain traditional financing or are unwilling to take the risks and assume the debt obligations for traditional financing. Project financing permits the risks associated with such projects to be allocated among a number of parties at levels acceptable to each party. For example, for an energy generation facility, there usually has to be a long-term off-take agreement or power sales agreement and the purchaser has to have good credit. 34 A tribe developing wind power generation may obtain a power sales agreement from a utility who agrees to purchase the power generated by the project for a stated term. Any utility that agrees to purchase the product must have good credit. The power sales agreement and the anticipated revenues could be pledged as security to obtain a loan for the construction and development of the project. The tribal developer would not have an obligation to make payments on the project loan if the revenues generated by the project are insufficient to cover the loan payments. This type of financing allows the developer to finance the project on a highly leveraged basis. Often, projects are financed using 80 to 100 percent debt financing. A developer’s funds are at less risk as it permits a developer to finance the project without diluting its equity investment in the project. II-9 6. Advantages and Disadvantages Advantages and Disadvantages--It can be challenging for a tribe that chooses to operate and manage a commercial enterprise through an unincorporated arm of the tribe. Since an unincorporated commercial enterprise of the tribe is acting as an extension of the tribe it is not set up as a separate legal entity from the tribe itself. The tribe will enter into a contract in its own name. The assets and property of unincorporated enterprise is not conveyed to a separate legal entity and can not be separately pledged as collateral. Thus it is more difficult to minimize the financial risks of the tribe by segregating the assets of the unincorporated enterprise. The advantages of operating a business as an unincorporated instrumentality of the tribe include: • Easy to form since it is formed as an arm of the tribal government--no need to set up a separate legal entity • Management is centralized through tribal governmental officials • Entity will have the same privileges and immunities as the tribal government including tribal sovereign immunity • Not subject to federal income tax • Section 81 approval by the Secretary of the Interior required if contracts or agreements encumber Indian land for a term of 7 years or more. Disadvantages include: • Politics and business not separated • Assets and liabilities of the enterprise are not segregated from governmental assets • Wholly-owned tribal entity--would preclude equity ownership in enterprise by outside investors. A major disadvantage of an unincorporated instrumentality of the tribe is that it does not separate politics from the day-to-day business operation of the tribe and the tribe assumes liability for all of the obligations and liabilities of the enterprise. This can result in micro-managing of a business enterprise which may hinder the tribal council’s ability to set overall strategic economic development objectives. II-10 Case Study—Mohegan Tribal Gaming Authority In 1995, the Mohegan Tribe of Indians of Connecticut, a federally-recognized tribe, adopted a tribal ordinance that established the Mohegan Tribal Gaming Authority as an instrumentality of the tribal government. The Authority was created under an ordinance established under tribal law. The Authority is governed by a Management Board comprised of the same nine members that serve on the Tribal Council. The nine-member Tribal Council serves four-year staggered terms; any change to the Tribal Council results in a corresponding change to the Management Board. The Authority is managed by a CEO who is hired by the Management Board. The CEO makes the day-to-day business management decisions for the Mohegan Sun. The Authority has been granted the exclusive power to conduct and regulate gaming activities on the existing reservation of the Tribe and non-exclusive authority to conduct activities elsewhere. In 1996, the Authority opened the Mohegan Sun casino and entertainment center on their reservation. In 2005, the Authority purchased a racing facility and five off-track wagering facilities in Pennsylvania, and formed the Mohegan Sun at Pocono Downs. The Authority has wholly-owned subsidiaries: Mohegan Basketball Club LLC, Mohegan Ventures-Northwest LLC, and Mohegan Commercial Ventures PA, LLC. As part of its diversification efforts, Mohegan Ventures-NW owns a 54.15% in Salishan- Mohegan LLC, formed with an unrelated third party to participate in the development and management of a casino to be owned by the Cowlitz Indian Tribe in Washington. Both Mohegan Ventures-NW and Salishan Mohegan are designated as unrestricted subsidiaries of the Authority and are not required to be guarantors of the Authority’s debt obligations. Source: Mohegan Sun Casino and Tribal Gaming Authority 2005 Annual Report. II-11 Case Study—Eagle Tech Systems Eagle-Tech Systems (ETS) is a wholly-tribally owned computer services company. Originally started in 1972 as an internal information technology department by the Warm Springs tribal government, it was renamed ETS in January 2004. The ETS office is located on the Warm Springs Indian Reservation in North Central Oregon. The Confederated Tribes of the Warm Springs Reservation is a confederation of three Indian tribes organized pursuant to the Indian Reorganization Act of 1934 (IRA). The Tribe has both a Constitution and Bylaws approved pursuant to Section 16 of the Act and a federal corporate charter issued pursuant to Section 17 of the Act. In both capacities it is governed by an 11 member tribal council. The Tribe has approximately 4,500 members. Its lands include 640,000 acres within the reservation boundaries, and some thousands more acreage off reservation within its original lands ceded to the U.S. Government in 1855. It has a variety of enterprises including a lumber mill, vacation resort, casino, composite materials manufacturing plant, museum, construction enterprise, credit enterprise, and hydroelectric power generation enterprise. Some of these are formed under the federal corporate charter and others, like Eagle-Tech Systems (ETS), are formed pursuant to provisions of the constitution. Eagle-Tech Systems is not a corporation, partnership, LLC, LLP, sole proprietorship or other form of legal organization commonly used off the reservation. Rather, it is a unique entity formed under the Tribal Constitution that has many of the attributes of the most common forms of business organizations. The Tribal Constitution empowers the Tribal Council "to charter subordinate organizations for economic purposes and to regulate the activities of all cooperative associations of members of the Confederated Tribes." Pursuant to this provision the Tribal Council, by resolution, has chartered Eagle-Tech Systems as a "subordinate organization for economic purposes." Under the charter, it is governed by a board of directors appointed by the Tribal Council. It is managed on a day-to-day basis by a General Manager selected by the board of directors. As a legal entity, it can be described as a "subordinate organization of the Warm Springs Tribe chartered for economic purposes by the Tribal Council of the Confederated Tribes of the Warm Springs Reservation pursuant to the provisions of its Constitution adopted pursuant to the provisions of Section 16 of the Indian Reorganization Act of 1934". Source: Eagle Tech Systems II-12 B. Political Subdivision of Tribal Government Political subdivisions are increasingly utilized by Indian tribal governments as quasi-business entities because of the close link between economic development (a governmental function) and tribal ownership and conduct of businesses. In some cases, such subdivisions are being formed as Economic Development Authorities that serve two functions: (1) as holding companies for business entities owned by the tribe; and (2) as regulatory bodies for business operations within the tribe's jurisdictional area. In other cases, political subdivisions are utilized to own and operate a specific enterprise or activity that has both a governmental and a business aspect to it, such as energy development, gaming or housing. 1. Brief Description and Examples A political subdivision of an Indian tribal government is a unit of the government that: • Is, to some degree, separate from the government itself • Is created under tribal law to fulfill a substantial governmental function of the government • Has been delegated a sufficient amount of one or more recognized sovereign powers of the tribe. Recognized sovereign powers include, for the purpose: (1) the power to tax; (2) the power of eminent domain; and (3) a police or regulatory power. This past year, the IRS ruled that a tribal business development authority (the "Authority") may constitute a political subdivision of a federally recognized Indian tribe (the "Tribe"). In Private Letter Ruling ("PLR") 200635002, the Tribe, through its Tribal Council, established the Authority as a political subdivision of the Tribe. Authority was given the power to impose and collect (1) business income or franchise taxes, sales and use taxes, and other business-related taxes on any persons (limited to business entities chartered by the Tribe), transactions, or activities within Tribe's taxing jurisdiction, and (2) service and licensing fees on business enterprises operating within Tribe's taxing jurisdiction. The Tribe retained significant control over the Authority even though it was a separate entity. For example, it provided that all five members of Authority's governing board could be removed by the Tribal Council at any time with or without cause. Furthermore, the Authority's capital and operating budgets were subject to Tribal Council approval before they became effective, while financial balance sheets and quarterly reports were required to be filed with the Tribal Council. II-13 The IRS found the Tribe effectively delegated all the power to tax, and one or more of the substantial governmental functions within the meaning of section 7871(d) of the Code. Therefore, the IRS held Authority will be treated as a political subdivision of 35 Tribe under section 7871 of the Code. Other examples of political subdivisions that have been recognized as such by the IRS
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