PLR 200542001: Developer's utility payments count as taxable construction aid

Plain-English summary

A developer paid an electric utility to bury lines around a building site and planned to pay for a connection to an existing underground line. The perimeter lines were not needed to serve the building, but local approval required the developer to bury them to obtain permits. The IRS found that both payments benefited the developer because the project could not proceed without them. It ruled that the payments were contributions in aid of construction under section 118(b) and therefore included in the utility's gross income under section 61.

Ruling snapshot

• Question: Could the utility exclude the developer's payments for undergrounding and connection from gross income?
• Outcome: Denied: both payments are taxable contributions in aid of construction.
• Key authorities: IRC §§ 61, 118(a), 118(b); Notice 87-82.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200542001
Third Party Communication: None
Release Date: 10/21/2005
Date of Communication: Not Applicable
Index Number: 118.02-02
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B05
In Re:
PLR-100849-05
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Date:
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July 06, 2005
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LEGEND

Corp A = ------------------------------------------------------------------------------------------------
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Parent = ------------------------------------------------------------------------------------------------
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Developer = ------------------------
County = ----------------------------

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

This letter responds to your letter, dated December 29, 2004, and subsequent correspondence, requesting a ruling under section 118 of the Internal Revenue Code.

FACTS

Corp A is a wholly-owned subsidiary of Parent and a member of the Parent affiliated group that files a consolidated return. Corp A is a regulated public utility within the meaning of section 7701(a)(33). Corp A is in the business of generating, transmitting, and distributing electric power. Corp A owns, operates, and maintains the electric distribution system.

Developer is developing a large, apartment building with retail space in County.
As part of the site approval process, County required Developer to underground certain utility lines that are along the perimeter of the property. The lines required to be undergrounded by County will not be used as a connection site to provide service to this location. Corp A is currently serving this location from an existing underground line. Even though Developer is constructing a new building, the required undergrounding is not necessary to provide service for this building, but it is part of County’s undergrounding plan. Developer must underground these lines to get the necessary permits for the building. Developer made a payment to Corp A to underground the

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perimeter lines. Developer will make a payment to Corp A to connect to the existing underground line.

LAW AND ANAYSIS

Section 61(a) and section 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 section 824(a) of the Tax Reform Act of 1986 (the Act), provides that for section 118(a) purposes, the term “contribution to the capital of the taxpayer” does not include any contribution in aid of construction (CIAC) or any other contribution as a customer or potential customer.

Before the Act, former section 118(b) allowed certain regulated public utilities to exclude from gross income as contributions to the capital of the corporation certain contributions made by a customer or potential customer in aid of construction. Section 824(a) of the Act repealed this special exclusion by amending section 118(b). The changes made by the Act apply to all contributions after that date. As a result of this change, all CIACs, even those received by a regulated public utility such as Corp A, are includible in gross income. Although not applicable to Corp A, section 118 was subsequently amended by the Small Business Job Protection Act of 1996 to restore the benefits of the provisions repealed by the Act for regulated public utilities that provide water or sewage disposal service.

The House Ways and Means Committee Report for the Act explains that property, including money, is a CIAC (rather than a capital contribution) if it is transferred to provide or encourage the provision of services to or for the benefit of the person transferring the property. H.R. Rep. No. 426, 99th Cong., 1st Sess. 644 (1985), 1986-3 (Vol. 2) C.B. 644 (the House Report). A utility has received property to encourage the provision of services if the receipt of the property is a prerequisite to the provision of the services; if the receipt of the property results in the provision of services earlier than would have been the case had the property not been received; or if the receipt of the property otherwise causes the transferor to be favored in any way. Id. The House Report also states that the repeal of the special exclusion does not affect transfers of property that are not made in connection with the provision of services, including situations where it is clearly shown that the benefit of the public as a whole was the primary motivating factor in the transfers. Id.

Notice 87-82, 1987-2 C.B. 389, provides additional guidance. Notice 87-82 follows the language from the House Report and states that a payment received by a utility is not a CIAC if it does not reasonably relate to the provision of services by the utility to or for the benefit of the person making the payment, but rather relates to the benefit of the pubic at large. Notice 87-82 provides as an example of a payment benefiting the public at large a relocation payment received by a utility under a

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government program to place utility lines underground. In that situation, the relocation payment is not considered a CIAC where the relocation is undertaken for purposes of community aesthetics and public safety and does not directly benefit particular customers of the utility in their capacity as customers.

Under the site approval plan, Developer could not develop the site unless it paid for both undergrounding the perimeter lines and connecting to the existing underground line. Consequently, these payments made by Developer to Corp A will be for its benefit.

CONCLUSION

Accordingly, based solely on the foregoing analysis and the representations made, we conclude that the payments made by Developer to Corp A to underground the perimeter lines and to connect to the existing underground line are a CIAC under section 118(b) included in gross income under section 61.

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.

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.

A copy of this letter should be filed with Parent’s federal income tax return for the taxable year in which the payment is made.

In accordance with the power of attorney on file with this ruling request, a copy of this letter is being sent to Parent’s authorized representative.

Sincerely,

SUSAN J. REAMAN
Branch Chief, Branch 5
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures (2):
Copy of this letter
Copy for section 6110
cc: