The IRS recently issued Notice 2016-36 providing a safe harbor under which transfers of property used to facilitate the transmission of electricity over a regulated utility’s transmission system from an electricity generator to the public utility will not be treated as income under section 118.
Background: Public Utilities Regulatory Policies Act Regulations
The Public Utilities Regulatory Policies Act of 1978 and the Federal Energy Regulatory Commission regulations thereunder require a utility to interconnect with qualifying small power producers and qualifying cogenerators (“qualifying facilities”) for the purpose of allowing the sale of power produced by the qualifying facilities. The qualifying facility is required to bear the cost of the purchase and installation of any equipment required for the interconnection, called an “intertie.” An intertie includes new connecting and transmission facilities, or modifications, upgrades, or relocations of a utility’s existing transmission network that enable or facilitate the interconnection of a generator with a utility or improve efficiency on the utility’s transmission network. Qualifying facilities generally sell electricity to utilities pursuant to long-term power purchase contracts, and some of these contracts require the qualifying facility to construct and install the intertie and transfer it to the utility. Generally, the utility takes legal title to the intertie which becomes part of the utility's transmission network.
Under section 118, contributions to capital of a corporate taxpayer made by persons other than shareholders are not included in gross income. Section 118(b) provides that the term “contribution to the capital of taxpayer” does not include any contribution in aid of construction (CIAC) or any other contribution as a customer or potential customer. The legislative history of section 118 suggests that Congress added the exclusion from income for contributions to capital of a corporation by non-shareholders to address situations in which such contributions cannot be called gifts because the contributors expect to derive indirect benefits; however, the contributions cannot be characterized as payments for future services because the expected future benefits are too remote. H.R. Rep. No. 1337, 83rd Cong., 2d Sess. 17 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 18-19 (1954).
Previous IRS Guidance (Notices 88-129, 90-60, and 2001-82)
Notice 88-129 created a safe harbor that allows a utility to avoid recognition of income upon the receipt of an intertie from a qualifying facility that occurs in connection exclusively with the sale of electricity by the qualifying facility. The safe harbor requires the transfer of the intertie to occur in connection with a power purchase contract with the utility having a term of at least 10 years. The possibility that an intertie may be used to transmit power to a utility that will in turn transmit the power across its transmission network for sale to another utility (“wheeling”) would not cause the contribution of that intertie to be treated as a CIAC includible in income pursuant to section 118(b). Notice 88-129 provides that the cost of the intertie is required to be capitalized by the qualifying facility as an intangible asset.
Notice 90-60 provided rules for determining the fair market value of a CIAC that resulted from a transfer of an intertie that failed to meet the requirements of Notice 88-129.
Notice 2001-82 extended the safe harbor provisions of Notice 88-129 to include transfers of interties from both qualifying and non-qualifying facilities and transfers of interties used exclusively or in part for wheeling electricity. Notice 2001-82 requires that ownership of the wheeled electricity pass to the purchaser prior to its transmission on the utility’s transmission grid. In addition, Notice 2001-82 provides that a long-term interconnection agreement in lieu of a long-term power purchase contract could be used to satisfy the safe harbor provisions of Notice 88-129 with respect to wheeling transactions.
As Notice 2016-36 describes, since the issuance of the previous notices, electricity transmission and distribution systems have evolved and become interlinked so that close coordination of operations within the major US power grids is needed to maintain the various components. Power utilities have become interlinked in order to reduce costs by diversifying energy sources and to respond better to energy usage needs. Notice 2016-36 updates the previous guidance to accommodate changes in industry practices and technological advances and associated issues, such as grid congestion.
Notice 2016-36 provides a new safe harbor in which a transfer of an intertie to a regulated public utility will not be treated as a CIAC under section 118(b) and instead be treated as a contribution to capital under section 118(a). The safe harbor applies as long as the intertie transmits electricity and any power that flows back from the utility to the generator over the intertie does not exceed five percent of the projected total power flows over the next 10 years. In addition, the cost of the intertie must not be included in the utility’s base rate.
This notice consolidates the safe harbor requirements under Notices 88-129, 90-60, and 2001-82, and removes the requirement that the generator must have a long-term power purchase contract or long-term interconnection agreement with the utility that constructs the upgrades. The elimination of this requirement allows utilities to deal with the problem of overloaded transmission lines by enabling an electricity generator and a utility located in different regions to enter into an agreement in which the utility constructs upgrades to its transmission system, allowing it to handle the generator’s new capacity, and the generator reimburses the utility for the cost of the upgrades. Because no long-term power purchase contract or long-term interconnection agreement is required under the new safe harbor, a generator (such as a solar or wind farm) may contribute an intertie to a utility that qualifies under the new safe harbor even if the generator is interconnected with a distribution system, rather than a transmission system, if the requirements of Notice 2016-36 above are met.
In addition, this notice extends the provisions of the safe harbor to transfers of interties from energy storage facilities to regulated public utilities. As explained in the notice, energy storage facilities help to maintain consistency and frequency of the power grid and react to changes in electricity demand. Treasury and the IRS believe that these modifications will promote reliability and economic efficiency throughout the grid and the development and interconnection of renewable energy resources.
Notice 2016-36 applies to transfers meeting all of the specified requirements made on or after June 20. Taxpayers may, however, choose to rely on this safe harbor with respect to qualifying transfers made prior to June 20. The IRS will not issue private letter rulings involving this safe harbor.