PLR 200638002: Utility interconnection facilities qualify as capital contribution

Plain-English summary

A contributor agreed to fund facilities connecting its power operation to a utility's transmission system, while the utility would construct and own the facilities. The parties represented that the contributor was not a utility customer, the connection would not be included in the utility's rate base, and the interconnection arrangement would last while the contributor's operation remained commercial. The IRS concluded that the facilities transfer was not a taxable contribution in aid of construction under section 118(b). It also found that the transfer had the characteristics of a nonshareholder capital contribution and was excluded from the utility's gross income under section 118(a). The ruling addressed the facilities transfer, not other tax consequences of the arrangement.

Ruling snapshot

• Question: Is the facilities transfer excluded from the utility's income as a nonshareholder capital contribution?
• Outcome: Approved; the transfer is not a contribution in aid of construction and is excluded under section 118(a).
• Key authorities: IRC § 118(a), (b); Treas. Reg. § 1.118-1; Notices 88-129 and 2001-82.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200638002
Third Party Communication: None
Release Date: 9/22/2006
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:
In Re:
CC:PSI:B05
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PLR-100149-06
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Date:
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June 14, 2006

LEGEND

Taxpayer = ------------------------------------------------------------------------
Company A = -----------------------------------------------
Contributor = ------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Agreement = --------------------------------------------------------------------------
W = -----------------------------------------------------------------
X = ---------------------------------------------
Y = ----------------------------------------------------------------
Z = -----

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

This letter responds to a letter submitted on behalf of Taxpayer, dated December 27, 2005, and subsequent correspondence, requesting a ruling under ' 118 of the Internal Revenue Code.

FACTS

Taxpayer owns W. Taxpayer is an indirect, wholly-owned subsidiary of Company A. Company A files a consolidated federal income tax return. Taxpayer is a member of Company A’s affiliated group. Contributor is an X company that owns Y.

Contributor and Taxpayer have entered into an Agreement allowing Contributor to connect to Taxpayer’s W so that Contributor’s Z can be brought to market. The Agreement provides that Taxpayer will construct and own the facilities described in the Agreement and that Contributor will reimburse Taxpayer for the cost of the construction.
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Taxpayer and Contributor represent that the Agreement will remain in effect for as long as Y remains in commercial operation and that Contributor is not a customer or potential customer of Taxpayer.

In addition, Taxpayer represents the following: (1) Taxpayer will not include the facilities in its rate base; (2) Contributor will capitalize the cost of the facilities and will recover such cost using the straight-line method over 20 years; (3) the facilities will not be a dual-use intertie; and (4) title to the Z will pass to the Contributor’s customers at the point of receipt before the Z enters Taxpayer’s W.

RULING REQUESTED

Taxpayer requests the Service to rule that the transfer by Contributor to Taxpayer of the facilities 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 the taxpayer@ does not include any CIAC or any other contribution as a customer or potential customer.

Section 1.118-1 of the regulations 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 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
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the subject. H.R. Rep. No. 1337, 83d Cong., 2d Sess. 17 (1954); S. Rep. No. 1622, 83d 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 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 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.
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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 recover using the straight-line method over a useful life of 20 years.

In the instant case, the transfer of the facilities by Contributor to Taxpayer possesses the characteristics of a transfer described in Notice 88-129, as amended and modified by Notice 90-60 and Notice 2001-82. Thus, we conclude that the contribution of the facilities by Contributor to Taxpayer will not be a CIAC under ' 118(b).

Next, we must decide whether the transfer qualifies as a contribution to capital under ' 118(a).

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, 83d 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.
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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 (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 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.

In the instant case, the transfer of the facilities by Contributor to Taxpayer possesses the characteristics of a nonshareholder contribution to capital described in Chicago, Burlington & Quincy Railroad Co. Thus, we conclude that the transfer of the facilities by Contributor to Taxpayer will be a nonshareholder contribution to capital under ' 118(a).

Accordingly, based solely on the foregoing analysis and the representations made by Taxpayer and Contributor, we conclude that the transfer of the facilities by Contributor to Taxpayer will not be a CIAC under ' 118(b) and will be excludable from
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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.

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

In accordance with the power of attorney on file, a copy of this letter is being sent to Taxpayer=s authorized representative.

Sincerely,

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

Enclosure: 6110 copy