Transmission-upgrade reimbursements are taxable CIACs

Plain-English summary

An electric utility built transmission interconnection facilities and system upgrades required to connect a privately developed project between two regional grids. The project owner reimbursed the utility's construction costs, which the utility had reported as taxable income. The IRS agreed that the payments were contributions in aid of construction under section 118(b), not excludable nonshareholder capital contributions under section 118(a). The reimbursements were prerequisites to providing interconnection services, favored the project owner, and compensated the utility for specific construction services.

Ruling snapshot

• Question: Were reimbursements for electric-transmission system upgrades contributions in aid of construction rather than excludable capital contributions?
• Outcome: Approved; the payments were CIACs under section 118(b) and not capital contributions under section 118(a)
• Key authorities: IRC § 118; Detroit Edison Co.; Brown Shoe Co.; Chicago, Burlington & Quincy Railroad Co.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201532029
Release Date: 8/7/2015

Third Party Communication: None
Date of Communication: Not Applicable

Index Number: 118.00-00

Person To Contact:

Telephone Number:

Refer Reply To:
CC:PSI:5
PLR-143028-14

Date:
May 04, 2015

Legend

Taxpayer =
Corp 1 =
Corp 2 =
Corp 3 =
State 1 =
State 2 =
State 3 =
Project =
Tax Years =

Dear :

This letter responds to a request for a ruling dated November 14, 2014,
submitted on behalf of Taxpayer by your authorized representatives. Taxpayer

PLR-143028-14 2

requested a ruling that payments received by Taxpayer for certain electric transmission
system upgrades are contributions in aid of construction under § 118(b) of the Internal
Revenue Code. The relevant facts as represented in your submission are set forth
below.

Taxpayer, a State 1 corporation, is an electric utility primarily engaged in the
transmission and distribution of electric energy in State 1. Corp 1, a State 3 limited
liability company, is a regional transmission organization authorized by the Federal
Energy Regulatory Commission (FERC) to coordinate the movement of electricity over
the electric transmission system serving several states (Corp 1 Control Area). Corp 1
manages all interconnections of generators, merchant transmission facilities, and other
utility transmission systems connecting with the Corp 1 Control Area, including the
transmission interconnections of the Project with Taxpayer.

Corp 2, a State 3 limited liability company, developed, permitted, financed, built,
owns, and operates the Project. Corp 3 is an independent system operator that is
authorized by FERC to coordinate the movement of electricity over the electric
transmission system serving State 2 (Corp 3 Control Area).

The Project establishes a connection between the regional transmission grids
administered by Corp 1 and Corp 3. The Project’s State 1 connection interties to an
electric transmission system owned and operated by Taxpayer (Taxpayer’s System). In
order to establish the intertie between the Project and Taxpayer’s System, Corp 1
required Taxpayer to construct transmission interconnection facilities and other
upgrades to its system (Upgrades). Pursuant to agreements among Corp 1, Taxpayer,
and Corp 2, Corp 2 was liable for reimbursing Taxpayer for the costs of the Upgrades.
Procedurally, Taxpayer billed the costs of constructing the Upgrades to Corp 1 and
Corp 1 billed Corp 2 on Taxpayer’s behalf.

Taxpayer received reimbursement payments from Corp 2 for the construction of
the Upgrades in the Tax Years. In each applicable tax year, Taxpayer reported the
payments as taxable income on its Federal tax returns.

Pursuant to FERC rate-making policy, Taxpayer does not include the cost of the
Upgrades in its rate base. Taxpayer wishes to pursue an order from FERC pursuant to
Section 206 of the Federal Power Act requiring the interconnecting entity, namely
Corp 2, to reimburse Taxpayer for income taxes attributable to the Upgrade
reimbursement payments.

Taxpayer requests a ruling that the payments Taxpayer received for the costs of
constructing the Upgrades are contributions in aid of construction (CIACs) under
§ 118(b).

Section 61 and § 1.61-1 of the Income Tax Regulations provide that gross
income means all income from whatever source derived, unless excluded by law.

PLR-143028-14 3

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) provides that the term “contribution to the capital of the taxpayer”
does not include any contribution in aid of construction or any other contribution as a
customer or potential customer.

Section 1.118-1 of the Income Tax Regulations provides that in the case of a
corporation, § 118 provides an exclusion from gross income with respect to any
contribution of money or property to the capital of the taxpayer. Thus, if a corporation
requires additional funds for conducting its business and obtains such funds through
voluntary pro rata payments by its shareholders, the amounts so received being
credited to its surplus account or to a special account, such amounts do not constitute
income, although there is no increase in the outstanding shares of stock of the
corporation. In such a case the payments are in the nature of assessments upon, and
represent an additional price paid for, the shares of stock held by the individual
shareholders, and will be treated as an addition to and as a part of the operating capital
of the company. Section 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 inducing the corporation to locate its business in a particular community,
or 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 a
corporation in consideration for goods or services rendered, or to subsidies paid for the
purpose of inducing the taxpayer to limit production.

The legislative history of section 118 provides, in part, as follows:

This [section 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 customer’s payments to a utility
company for the estimated cost of constructing service facilities (primary power lines)

PLR-143028-14 4

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
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.

Section 118(b) as it now appears in the Code was added by section 824 of the
Tax Reform Act of 1986, Pub. L. No. 99-514 (the Act). 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. 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

PLR-143028-14 5

received; or if the receipt of the property otherwise causes the transferor to be favored
in any way. Id.

The payments received by Taxpayer were a prerequisite to the provision of
services and caused Corp 2, the transferor, to be favored. Taxpayer concludes that the
payments for the Upgrades are CIACs under § 118(b). Additionally, Taxpayer
represents that the Upgrades are compensation for Upgrade construction services
provided for Corp 2 and do not satisfy all of the required characteristics in Chicago,
Burlington & Quincy Railroad Co.

Accordingly, we rule that the payments Taxpayer received for the costs of
constructing the Upgrades are CIACs under § 118(b) and are not contributions to the
capital of Taxpayer 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 requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

In accordance with the power of attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.

Sincerely,

Paul F. Handleman
Chief, Branch 5
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc: