PLR 201005002: Intertie transfer treated as a capital contribution

Plain-English summary

A power producer planned to transfer an intertie and possibly cash for related construction to a public utility. The utility asked whether the transfer would be a contribution in aid of construction or instead a nonshareholder contribution to capital. The IRS ruled that the transfer would not be a contribution in aid of construction under IRC § 118(b) and would be excludable from the utility's gross income as a nonshareholder contribution to capital under § 118(a). The ruling relied on the intertie's use for transmitting electricity for sale to third parties, the parties' representations, and the applicable IRS notice safe harbors.

Ruling snapshot

• Question: Would the intertie transfer be a contribution in aid of construction or a nonshareholder contribution to capital?
• Outcome: Approved.
• Key authorities: IRC §§ 61(a), 118(a), and 118(b); Treas. Reg. § 1.118-1; Notices 88-129, 90-60, and 2001-82.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201005002
Third Party Communication: None
Release Date: 2/5/2010
Date of Communication: Not Applicable
Index Number: 118.01-02, 118.02-00
Person To Contact:
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---------------, ID No. -----------------
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Telephone Number:
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Refer Reply To:
In Re: ---------------------------------------------------- CC:PSI:5
--------------------------------------------------------- PLR-120667-09 Date:
October 16, 2009

Legend:

Taxpayer = ---------------------------------------------------------------------------------
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Corp 1 = ---------------------------------------------------------------------------------
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Producer = --------------------------------------------------------------------------------
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Dear ----------------:

This letter responds to your letter dated ---------------------, requesting a letter ruling concerning whether the transfer of an intertie from Producer to Taxpayer is a nonshareholder contribution to capital excludable from Taxpayer’s income under § 118(a) of the Internal Revenue Code.

FACTS

Taxpayer represents that the facts are as follows.

Taxpayer, a wholly-owned subsidiary of Corp 1, is a public utility incorporated in - -------------. Taxpayer’s business involves the purchase, transmission, distribution and sale of electricity and natural gas services. Taxpayer files its federal income tax return as part of the consolidated return of Corp 1.
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Corp 1 is the common parent of an affiliated group of corporations including Taxpayer. Corp 1’s core business is the transmission and distribution of electricity in --- --------------and ------------------. Corp 1 is a subsidiary of --------------. Corp 1 files a consolidated federal income tax return for its affiliated group.

Producer was formed to build, own and operate a power plant in ---------------------- -------------. Since its formation, Producer has been treated as a disregarded entity for federal income tax purposes. Its sole member is --------------------------------- -------------. -- ---------, a ------------- limited liability company, was formed to own Producer------------------ sole member is ----------------------------------.

Producer is developing a cogeneration power production facility to be located in - -----------------------------. Producer and Taxpayer, entered into a --------- year Interconnection Agreement, dated to be effective -----------------------, (the IA). The IA was filed with and accepted by the Federal Energy Regulatory Commission in -------.

Producer intends to construct an intertie to interconnect with Taxpayer’s transmission system to transmit electricity for sale to third parties. Producer will transfer all ownership of the intertie to Taxpayer. The components of the intertie to be transferred by Producer include, but are not limited to, certain electricity interconnection assets, high voltage transmission lines, safety equipment, related easements, licenses and permits, and the interconnection facility.

Upon transfer of the intertie by Producer, Taxpayer will be the owner and sole operator of the intertie and the intertie will become a permanent part of Taxpayer’s transmission system that can be used by Taxpayer in its trade or business in producing gross income. Taxpayer will operate, maintain and repair the intertie, and Producer will reimburse Taxpayer for certain maintenance and repair costs. In addition, Taxpayer will own or control all of the real property comprising the intertie. Producer is required to reimburse Taxpayer for the cost of any real property taxes required to be made by Taxpayer attributable to the interconnection facility portion of the intertie. It is represented that Taxpayer will at all times retain sole possession and control of the intertie and all real property relating thereto.

Taxpayer further represents: (1) The intertie will not be included in Taxpayer’s rate base; (2) Taxpayer will not take any depreciation deductions with respect to the intertie; and (3) the intertie will become a permanent part of Taxpayer's working capital structure, will not be compensation, such as a direct payment for a specific, quantifiable service provided to Producer by Taxpayer, will be bargained for, foreseeably will result in a benefit to Taxpayer in an amount commensurate with its value, and ordinarily will be employed in or contribute to the production of additional income and its value assured in that respect.
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Producer represents: (1) The production facility is a stand-alone generator as contemplated under Notice 2001-82; (2) The interconnection facility portion of the intertie will be used in connection with the transmission of electricity for sale to third parties, and no part of the intertie is necessary solely for the transmission of electricity to the production facility or Producer; (3) title and ownership of any electricity sold to power marketers or other purchasers will not be with Producer prior to its transmission on the grid; title to electricity will pass to each power marketer or other purchaser at the busbar on Producer’s end of the interconnection facility portion of the intertie before the electricity hits the interconnection point; (4) the cost of the intertie will be capitalized by Producer as an intangible asset and recovered using the straight-line method over a useful life of 20 years; and (5) the portion of the intertie that is a dual use intertie is reasonably expected to carry no more than 5 percent of the projected power flows in both directions over the intertie during the first 10 taxable years beginning in the year the intertie is placed in service.

RULING REQUESTED

Taxpayer requests the Service to rule that the contribution of the intertie, or of cash for related construction, by Producer to Taxpayer will not be considered a contribution in aid of construction under § 118(b) (CIAC), and will be excludable from Taxpayer’s income as a non-shareholder 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 “contribution to the capital of taxpayer” does not include any CIAC or any other contribution as a customer or potential customer.

Section 1.118-1 of the Income Tax 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
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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, 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 CIACs 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). 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 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 interconnection equipment (intertie) by a Qualifying Facility. 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 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.

The notice also provides 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
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manner as an in-kind QF transfer.

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 such cost using the straight-line method over a useful life of 20 years.

In the instant case, the transfer of the intertie is subject to the guidance set forth in Notice 88-129, Notice 90-60, and Notice 2001-82 for the following reasons: (1) the production facility is a stand-alone generator as contemplated under Notice 2001-82; (2) Producer and Taxpayer entered into a long-term interconnection agreement with a term of -------- years; (3) the intertie will be used in connection with the transmission of electricity for sale to third parties (wheeling); (4) the cost of the intertie paid by Producer will not be included in Taxpayer’s rate base; (5) Taxpayer will not take any depreciation deductions with respect to the intertie; (6) based on all available information, the portion of the intertie that is a dual use intertie is reasonably expected to carry no more than 5 percent of the projected power flows in both directions over the intertie during the first 10 taxable years beginning in the year the intertie is placed in service; (7) ownership of the electricity produced by the facility that is wheeled will pass to the purchaser prior to its transmission on Taxpayer’s transmission grid; and (8) the cost of the intertie will be capitalized by Producer as an intangible asset and recovered using the straight-line method over a useful life of 20 years. Thus, we conclude that the deemed contribution of the intertie by Producer 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).

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
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called a gift; yet the anticipated future benefits may also be so intangible as to not warrant treating the 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 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), 1950-1 C.B.
38, 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 41.

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 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
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its value assured in that respect.

The transfer of the intertie by Producer to Taxpayer possesses the characteristics of a nonshareholder contribution to capital as described in Chicago, Burlington & Quincy Railroad Co. First, the intertie will become a permanent part of Taxpayer’s working capital structure. Second, the transfer is not compensation for services provided by for Producer by Taxpayer. Third, the transfer is a bargained-for exchange. Fourth, the transfer will foreseeably result in a benefit to Taxpayer commensurate with its value because the intertie will become part of Taxpayer’s transmission system. Fifth, the intertie will be used by Taxpayer in its trade or business for producing gross income. Therefore, Taxpayer’s receipt from Producer of the intertie will be a contribution to capital under § 118(a).

Accordingly, based solely on the foregoing analysis and the representations made by Taxpayer, we rule that the transfer of the intertie by Producer to Taxpayer will not be a CIAC 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.

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

Sincerely,

Nicole Cimino
Senior Technician Reviewer, Branch 5
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosure: 6110 copy