Loveland's Independent News Source
Loveland - June 12, 2012

LovelandPolitics received an angry email by a City of Loveland staff member following our story on the
city’s impending city-wide water rate increases scheduled for August.  The email complained about our
reference to “deferral” agreements for new developments of the water system impact fees as subsidies
which the staffer called “inaccurate, misleading and dishonest reporting.”

According to this city employee, the deferral agreements (of which there 124 water customers already
paying) are not subsidies because the full dollar amount is repaid eventually to the city (without
interest) by future occupants of the development via their future water bills.   Therefore, he argued
there is no real impact to Loveland water rate payers as a result of these deferral agreements.  

The City of Loveland provides some developers “deferrals” in the water tap (connection and
infrastructure) fees along with sewer connection and other related costs to the utility of adding new
users.   In theory, a deferral allows a developer the option to roll a one-time connection fee into future
water bills of their tenants.  Because the repayment is a fixed cost on top of the regular cost of water per
1,000 gallons, the repayment is dependent on the tenant or landlord (depending on who pays the water
bill) use of water in future years.

A Case In Point -

Loveland’s City Council recently approved an amendment to a deferral agreement on May 15, for a total
of $107,660 for a multi-family development located at 102-110 East First Street called Park Place Plaza.  
The original fee deferral for the project was provided in 2008 but it went into foreclosure after the
owner was unable to sell any condo units.  

On July 7, 2008 Loveland agreed to defer the Park Place Plaza water system impact fee and raw water
development fee applicable to a two-inch residential water meter to serve sixteen residences in the
development.  Apparently, nobody on staff or council reviewed the agreement or fee calculation in 2008
as it was calculated assuming only 1 building instead of 4 for the site.  Staff has now acknowledged their
error and informed council the true impact fees should have been calculated at $89,376 based on 16
units (4 buildings with 4 units each) instead of the $65,696 previously “deferred.”

The new property owner, an entity controlled by Henderson Property Management of Loveland, wants
to take advantage the currently profitable apartment rental market and modify the 4 buildings to
accommodate 20 instead of 16 residential units.   The addition of four more residences, combined with a
correction in the number of buildings brings the current fees now owed to $107,660.  Loveland’s Council
voted unanimously to amend the deferral agreement to cover $107,660 at the request of business
development staff and the developer.

Reported Water Utility Budget Impact

The memorandum provided by Mike Scholl, Economic Development Manager, to assist council in making
their decision checked the box “Neutral or negligible” instead of “positive” or “negative” in describing the
agreement’s budget impact to the city.  As further explanation, he provided the following statement;

“The deferral water and wastewater system impact fees and raw water development fee will be
recovered over time through the imposition of a capital recovery surcharge added to the monthly
utility bill in perpetuity.”

At first glance, it would appear reasonable given the fact the developer, Henderson Property
Management, will pass along to the tenants the $1.614 per 1,000 gallons surcharge.  

While Loveland’s Council was focused on the issue of future residents possibly paying double the cost of
water than their neighbors, few if any recognized the absurdity of calling a fee deferral that stretches out
213 years, as estimated by Councilman Hugh McKean during their discussion, as “payback” to the city
see video clip of discussion and vote).   Staff acknowledged they didn’t try and figure out when the city
will be
“paid back.”  

Curiously, the developer decided to add a separate water line for irrigation (landscaping) so the deferral
agreement recovery fee will only be assessed on the minimal indoor uses of water within the
apartments by the tenants.  In other words, the potentially higher usage of water at the property (paid
by the developer) for landscaping maintenance will not be burdened by the deferral payback
assessment imposed on residents for their indoor water usage.

Actual Water Utility Budget Impact

As approved by Loveland's Council, the deferral agreement is in substance a fee waiver as the
anticipated monthly payments for over $100,000 falls below even the normal rate of inflation.  Roughly
calculated, Councilors estimated the payback at less than $2,000 per year (anticipated indoor water
usage) or $160 per month stretching out over 200 years.  At a conservative rate of inflation of only 3%
this means the city’s principle would slowly erode as the “payments” don’t keep up with currency
devaluation.  In other words, the city never really recovers the 2008 and 2012 real costs to the utility of
the development’s impact through the deferral agreement because less than inflation rates will be paid
indefinitely by the apartment occupants via their water bill surcharge.

The IRS (Internal Revenue Service) would not allow the recipient to call the amount a loan (if this were a
private party transaction) because it clearly falls outside the IRS’s minimum definition of what is a loan.   
When taxpayers try to dress a gift or income as debt by making insignificant payments, the IRS adds
what is called “imputed interest” to determine whether the money was really a loan or a gift.  The Park
Plaza Place deferral agreement would be treated as a “gift” or income by the IRS because the amount of
repayment doesn’t even cover imputed interest let alone ever repay the principle amount of over

There is a common test in tax and finance law called “substance over form.”  In this case, the substance is
clearly a gift or fee waiver (subsidy in our vernacular) by the water utility to the developer because it
will never be repaid while the deferral agreement (form) pretends the city is being repaid over time.

A "substance over form" analysis can be used to unpack self-serving transactions between related
parties, including loans and payments to family members.  For example, a parent who sells their child a
home is often redefined by courts as a gift, if the child never really pays for it given the inconsequently
low amount of repayment expected (less than imputed interest).   The city’s deferral agreement would
likely meet the same test.  If not, nearly anyone could avoid paying income taxes by creating a sham loan
agreement with their employer.  The sham agreement could establish a repayment plan of $1 per year
in perpetuity (similar to the city's recent deferral agreement) going on for hundreds of years.

The legal term for this type of transaction is a “sham.”  A sham embodies two parts;   An agreement that
pretends the transaction to be something different than what it is and an actual transaction that
represents the substantive agreement between the parties.   Calling a waiver of water impact fees a
deferral appears to also meet the legal definition of a sham.  Because the City Council discussed the
repayment period at over 200 years (shortly before approving the agreement while laughing) it would
be difficult for them to later argue they thought the repayment period was sooner.

If I Can’t Legally Create Sham Transactions Why Is It Legal For the City To Create One?

It probably is not legal for the city to create sham deferrals but fee waivers are allowed.  The ordinance
cited in the city’s resolution approving the fee deferral,
16.38.071 Deferral of Fees, contemplates a
temporary deferral where eventually the city is repaid.  While the code doesn’t prescribe the specific
terms of any agreement, leaving that to council, it also doesn’t legally enable the council to approve a
subsidy which is covered in another area of city code which follows a slightly different legal protocol.  Of
course, the substance of the Park Place Plaza “deferral” is really a “subsidy” despite what Loveland’s staff
calls the agreement.

Below is the operative section of city code the Resolution passed by council cited authorizing a deferral
(not fee waiver) agreement.

16.38.071 Deferral of Fees

The city council may allow for the deferral of fees imposed on new development in the city.  The city
council may do so by approving by resolution a written agreement entered into with the person
owing the fees, which agreement shall contain such terms and conditions as the council determines
are in the best interests of the city and provided that the council also determines and finds in the
resolution that allowing the deferral of capital expansion fees or any other fees imposed on new
development will serve a public purpose.  A public purpose may include, without limitation, providing
the public with significant social, economic or cultural benefits.  
Water Sham
A Subsidy By Any Other Name
see 3 minute video clip of council meeting

Sham Doctrine Explained

Excerpt from website linked here

.U.S. v. Phellis, 257
U.S. 156, 168 (1921); Weinert’s Est. v.
Cm, 294 F. 2d 750, 755 (5
the  Cir. 1961).

The "form" of a transaction is generally
the label the parties attach to their
arrangement; for instance, they might
call an arrangement a  compensation
agreement, a loan, a lease or a sale.
There might be  documents that support
the form, but the courts are not
concerned with these labels or
documents that purport to govern the
transaction — the courts focus on the
substance of the transaction,
regardless of the labels used by the


The sham transaction concept
embodies two separate theories:

A sham in fact — which is a fictional
transaction that never actually occurred.

o A sham in substance is a transaction
that actually occurred but
which lacked the substance the form
allegedly represented. Kirchman v. Cm,
862 F. 2d 1486 (11
the Cir. 1989).

A sham in substance occurs when the
draws up papers to
characterize a transaction contrary to
the objective economic realities
which have no economic significance
beyond the expected tax benefits.
Falsetti v. Cm, 85 TC 332 (1985).

A transaction is considered a sham in
substance if it effects no real change in
each party’s economic position. For
example, a sale that fails  to transfer
beneficial ownership of property — in
which the payments circulate among
various parties in ways that cancel
themselves out — would be considered
a sham in substance.
In Rice’s Toyota World, Inc. v. Cm, 752
F.2d 89, 91 (4th Cir. 1985), the Court