PLR 200442015: Generator's intertie payment excluded as utility capital contribution

Plain-English summary

A generator built an intertie connecting its project to a utility's electric grid and agreed to pay the utility half of the intertie's cost. The electricity would be sold to third parties before transmission over the utility's grid, and the utility would not include the generator's payment in its rate base. The IRS found that the arrangement met the intertie transfer safe harbor and that the payment had the characteristics of a nonshareholder contribution to capital. It ruled that the payment was not a taxable contribution in aid of construction and could be excluded from the utility's income under § 118(a). The IRS did not decide whether the projected share of power flowing back to the generator was reasonable for the safe harbor's five percent test.

Ruling snapshot

• Question: Was the generator's share of intertie costs excluded from the utility's income as a capital contribution?
• Outcome: Approved on the represented facts, with the power flow projection not independently approved.
• Key authorities: IRC § 118(a), (b); Notices 88-129, 90-60, 2001-82; United States v. Chicago, Burlington & Quincy Railroad Co., 412 U.S. 401 (1973).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200442015
Third Party Communication: None
Release Date: 10/15/04
Date of Communication: Not Applicable
Index Number: 118.01-02, 118.02-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B05
In Re:
PLR-112474-04
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Date:
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June 25, 2004
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Taxpayer = ------------------------------------------------------------------------------------------------
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Generator = ---------------------------------
Project = ------------------------------------------------------------------------------------------------
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X = ----

Dear -----------------------:

This letter responds to your letter dated February 27, 2004, submitted on behalf of Taxpayer, requesting a letter ruling concerning whether the transfer of an intertie from Generator to Taxpayer is a nonshareholder contribution to capital excludable from income under ' 118(a) of the Internal Revenue Code.

FACTS

Taxpayer represents that the facts are as follows.

Generator built Project. Generator signed an interconnection agreement with Taxpayer that provides for the interconnection of Project with Taxpayer=s grid. The interconnection agreement has a term of X years.

Generator constructed an intertie, consisting of a switchyard and network upgrades. Taxpayer owns the intertie. Under the applicable tariff, Generator is obligated to pay Taxpayer for 50 percent of the cost of the Intertie. Generator’s 50 percent payment of the cost of the intertie is currently held in an escrow account pending receipt of a favorable letter ruling from the Service.

Generator is selling the electricity from Project into the regional bulk power market on the day ahead market, the real time market, and through bilateral contracts. Title to all power that is wheeled from Project will transfer to a third party prior to its
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transmission on Taxpayer=s grid. Generator has not and will not receive transmission credits from Taxpayer.

Taxpayer represents that Generator will treat its 50 percent payment of the cost of the intertie as basis in an intangible asset and recover its basis using the straight-line method over 20 years. Taxpayer also represents that the amount of power flowing back over the intertie to Generator will be less than five percent of the projected power flows in both directions over the intertie during Taxpayer=s first ten tax years after the intertie is placed in service. Taxpayer will not put Generator’s 50 percent payment of the cost of the intertie into its rate base.

Taxpayer represents that the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer possesses the characteristics of a nonshareholder contribution to capital under ' 118(a) as described in United States v. Chicago, Burlington & Quincy Railroad Co., 412 U.S. 401, 413 (1973).

RULING REQUESTS

Taxpayer requests the Service to rule that the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer to connect Project to Taxpayer=s grid is not a contribution in aid of construction (CIAC) under ' 118(b) and is excludable from Taxpayer=s gross income as a nonshareholder contribution to capital under ' 118(a).

LAW AND ANALYSIS

Section 61(a) and ' 1.61-1 of the Income Tax Regulations provide that gross income means all income from whatever source derived, unless excluded by law. Section 118(a) provides that in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. Section 118(b), as amended by ' 824(a) of the Tax Reform Act of 1986 (the 1986 Act) and ' 1613(a) of the Small Business Job Protection Act of 1996, provides that for purposes of subsection (a), except as provided in subsection (c), the term Acontribution 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.

Section 1.118-1 provides, in part, that ' 118 also applies to contributions to capital made by persons other than shareholders. For example, the exclusion applies to the value of land or other property contributed to a corporation by a governmental unit or by a civic group for the purpose of enabling the corporation to expand its operating facilities. However, the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered, or to subsidies paid to induce the taxpayer to limit production.

The legislative history to ' 118 indicates that the exclusion from gross income for nonshareholder contributions to capital of a corporation was intended to apply to those
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contributions that are neither gifts, because the contributor expects to derive indirect benefits, nor payments for future services, because the anticipated future benefits are too intangible. The legislative history also indicates that the provision was intended to codify the existing law that had developed through administrative and court decisions on the subject. H.R. Rep. No. 1337, 83rd Cong., 2d Sess. 17 (1954); S. Rep. No. 1622, 83rd Cong., 2d Sess. 18-19 (1954).

Notice 88-129, 1988-2 C.B. 541, as modified and amended by Notice 90-60, 1990-2 C.B. 345, and Notice 2001-82, 2001-2 C.B. 619, provides specific guidance with respect to the treatment of transfers of property to regulated public utilities by qualifying small power producers and qualifying cogenerators (collectively, Qualifying Facilities), as defined in section 3 of the Federal Power Act, as amended by section 201 of the Public Utilities Regulatory Policies Act of 1978 (PURPA).

The amendment of ' 118(b) by the 1986 Act was intended to require utilities to include in income the value of any CIAC made to encourage the provision of services by a utility to a customer. See H.R. Rep. No. 841, 99th Cong., 2d Sess. 324 (1986) (Conference Report). In a CIAC transaction, the purpose of the contribution of property to the utility is to facilitate the sale of power by the utility to a customer. In contrast, the purpose of the contribution by a Qualifying Facility to a utility is to permit the sale of power by the Qualifying Facility to the utility. Accordingly, the fact that the 1986 amendments to ' 118(b) render CIAC transactions taxable to the utility does not require a similar conclusion with respect to transfers from Qualifying Facilities to utilities.

Notice 88-129 provides, in part, that with respect to transfers made by a Qualifying Facility to a utility exclusively in connection with the sale of electricity by the Qualifying Facility to the utility, a utility will not realize income upon transfer of an intertie by a Qualifying Facility. An intertie may include new connecting and transmission facilities, or modifications, upgrades or relocations of a utility=s existing transmission network. 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 by the Qualifying Facility to another utility (wheeling) will not cause the contribution to be treated as a CIAC.

Further, the notice provides, in part, that a transfer from a Qualifying Facility to a utility will not be treated as a Qualifying Facility transfer (QF transfer) under this notice to the extent the intertie is included in the utility=s rate base. Moreover, a transfer of an intertie to a utility will not be treated as a QF transfer under this notice if the term of the power purchase contract is less than ten years.

Notice 88-129 also provides, in part, that a utility that constructs an intertie in exchange for a cash payment from a Qualifying Facility pursuant to a PURPA contract will be deemed to construct the property under contract and will recognize income from the construction in the same manner as any other taxpayer constructing similar property under contract. Subsequent to the construction of the property, the Qualifying Facility
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will be deemed to transfer the property to the utility in a QF transfer that will be treated in exactly the same manner as an in-kind QF transfer.

In addition, the notice provides, in part, that the contribution of a dual-use intertie to a utility will be treated as a QF transfer (and, therefore, nontaxable) if, in light of all information available to the utility at the time of transfer, it is reasonably projected that during the first ten taxable years of the utility, beginning with the year in which the transferred property is placed in service, no more than five percent of the projected total power flows over the intertie will flow to the Qualifying Facility.

Notice 2001-82 amplifies and modifies Notice 88-129. Notice 2001-82 extends the safe harbor provisions of Notice 88-129 to include transfers of interties from non- Qualifying Facilities, and transfers of interties used exclusively or in part to transmit power over the utility=s transmission grid for sale to consumers or intermediaries (wheeling). The notice requires that ownership of the electricity wheeled passes to the purchaser prior to its transmission on the utility=s transmission grid. This ownership requirement is deemed satisfied if title passes at the busbar on the generator=s end of the intertie. Further, Notice 2001-82 provides that a long-term interconnection agreement in lieu of a long-term power purchase contract may be used to satisfy the safe harbor provisions of Notice 88-129 in wheeling transactions. Finally, Notice 2001-82 requires that the generator must capitalize the cost of the property transferred as an intangible asset and recovered using the straight-line method over a useful life of 20 years.

In the instant case, the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer is subject to the guidance set forth in Notice 88-129, Notice 90-60, and Notice 2001-82 for the following reasons: (1) the Project is a stand-alone generator as contemplated under Notice 2001-82; (2) Generator and Taxpayer have entered into a long-term interconnection agreement; (3) the intertie will be used in connection with Generator=s sale of electricity wheeled over Taxpayer=s transmission grid to third parties; (4) Generator’s 50 percent payment of the cost of the intertie will not be included in Taxpayer=s rate base; (5) the intertie is a dual-use intertie; however, based on all available information, during the ten taxable years beginning with the year in which the intertie was placed in service, no more than five percent of the total power flows over the intertie will flow to Generator; (6) ownership of the electricity wheeled will not be with Generator prior to its transmission on the grid; and (7) Generator’s 50 percent payment of the cost of the intertie will be capitalized by Generator as an intangible asset and recovered using the straight-line method over a useful life of 20 years. Thus, we conclude that the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer meets the safe harbor requirements of Notice 88-129, as amended and modified by Notice 90-60 and Notice 2001-82.

Next, we must decide whether the contribution qualifies as a contribution to capital under ' 118(a).
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The legislative history of ' 118 provides, in part, as follows:

This [' 118] in effect places in the Code the court decisions on the subject.
It deals with cases where a contribution is made to a corporation by a governmental unit, chamber of commerce, or other association of individuals having no proprietary interest in the corporation. In many such cases because the contributor expects to derive indirect benefits, the contribution cannot be called a gift; yet the anticipated future benefits may also be so intangible as to not warrant treating the contribution as a payment for future services.

S. Rep. No. 1622, 83rd Cong., 2d Sess. 18-19 (1954).

In Detroit Edison Co. v. Commissioner, 319 U.S. 98 (1943), the Court held that payments by prospective customers to an electric utility company to cover the cost of extending the utility=s facilities to their homes, were part of the price of service rather than contributions to capital. The case concerned customers= payments to a utility company for the estimated cost of constructing service facilities (primary power lines) that the utility company otherwise was not obligated to provide. The customers intended no contribution to the company=s capital.

Later, in Brown Shoe Co. v. Commissioner, 339 U.S. 583 (1950), the Court held that money and property contributions by community groups to induce a shoe company to locate or expand its factory operations in the contributing communities were nonshareholder contributions to capital. The Court reasoned that when the motivation of the contributors is to benefit the community at large and the contributors do not anticipate any direct benefit from their contributions, the contributions are nonshareholder contributions to capital. Id. at 591.

Finally, in United States v. Chicago, Burlington & Quincy Railroad Co., 412 U.S.
401, 413 (1973), the Court, in determining whether a taxpayer was entitled to depreciate the cost of certain facilities that had been funded by the federal government, held that the governmental subsidies were not contributions to the taxpayer=s capital. The court recognized that the holding in Detroit Edison Co. had been qualified by its decision in Brown Shoe Co. The Court in Chicago, Burlington & Quincy Railroad Co. found that the distinguishing characteristic between those two cases was the differing purpose motivating the respective transfers. In Brown Shoe Co., the only expectation of the contributors was that such contributions might prove advantageous to the community at large. Thus, in Brown Shoe Co., since the transfers were made with the purpose, not of receiving direct services or recompense, but only of obtaining advantage for the general community, the result was a contribution to capital.

The Court in Chicago, Burlington & Quincy Railroad Co. also stated that there were other characteristics of a nonshareholder contribution to capital implicit in Detroit Edison Co. and Brown Shoe Co. From these two cases, the Court distilled some of the
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characteristics of a nonshareholder contribution to capital under both the 1939 and 1954 Codes. First, the payment must become a permanent part of the transferee=s working capital structure. Second, it may not be compensation, such as a direct payment for a specific, quantifiable service provided for the transferor by the transferee. Third, it must be bargained for. Fourth, the asset transferred foreseeably must benefit the transferee in an amount commensurate with its value. Fifth, the asset ordinarily, if not always, will be employed in or contribute to the production of additional income and its value assured in that respect. Chicago, Burlington & Quincy Railroad Co., 412 U.S. at 413.

Based on the facts represented, we conclude that the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer possesses the characteristics of a nonshareholder contribution to capital as described in Chicago, Burlington & Quincy Railroad Co. Therefore, the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer will be a contribution to capital under ' 118(a).

Accordingly, based solely on the foregoing analysis and the representations made by Taxpayer and Generator, we rule that the transfer by Generator of 50 percent of the cost of the intertie to Taxpayer will not constitute a contribution in aid of construction under ' 118(b) and will be excludable from the gross income of Taxpayer as a nonshareholder contribution to capital under ' 118(a).

Except as specifically set forth above, no opinion is expressed or implied concerning the federal income tax consequences of the above described facts under any other provision of the Code or regulations. Specifically, no opinion is expressed or implied as to whether Taxpayer=s representation that less than five percent of the total projected power flows over the dual-use intertie from Taxpayer to Generator is a reasonable projection for purposes of the five percent test in Notice 88-129.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Sincerely,

WALTER H. WOO
Senior Technician Reviewer, Branch 5
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosure: 6110 copy