Grid-frequency storage device was five-year service property

Plain-English summary

A taxpayer used a large electricity-storage device to stabilize grid frequency by taking electricity from the grid when frequency was high and returning it when frequency was low. The taxpayer asked the IRS to treat the device as property with no class life and therefore as seven-year property. The IRS found that the device was not electric generation, transmission, or distribution equipment because its primary function was providing frequency-regulation services and the grid could operate using other providers. The related electricity purchases and sales were ancillary to that service and produced no net sales income. The IRS classified the device in asset class 57.0 for distributive trades and services, giving it a nine-year class life and five-year recovery period.

Ruling snapshot

• Request: Classify the frequency-regulation storage device as seven-year property
• Outcome: Denied; the device was five-year property in asset class 57.0
• Key authorities: I.R.C. §§ 167, 168; Rev. Proc. 87-56

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201543001                                              Third Party Communication: None
Release Date: 10/23/2015                                       Date of Communication: Not Applicable
Index Number: 168.20-00
                                                               Person To Contact:
-------------------------                                      ------------------------, ID No. ------------------
----------------------------------------------------------     ----------------------------------------------------
---------------------------------------------------------      Telephone Number:
------------------------------------------                     ----------------------
                                                               Refer Reply To:
                                                               CC:ITA:7
                                                               PLR-101737-15
                                                               Date:
                                                               July 17, 2015




Re: ------------------------------------------------------------------

Legend

Parent                     =         ---------------------------------------------------------------
-------------------------------------------------------------

Taxpayer                   =         --------------------------------------------------
-------------------------------------------------------------

City                       =        ------------

State1                     =        --------------

State2                     =        -------

Date1                      =        -----------------

Date2                      =        -----------------

Storage Device             =        ---------------------------------------------------------------------------------
--------------------------------------------------------------------------

Unit                       =        ---------------------------------------------------------------------------------
----------------------------------------------------------------------

A                          =         -----------------------------------------------------
------------------------------------------------------------

B                          =        ----------------------------------------
PLR-101737-15                                             2

------------------------------------------------------------

C                          =        --------------------------------------

D                          =        --------------

E                          =        ------

F                          =        -------

G                          =        -----

H                          =        -----

I                          =        --

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

       This letter responds to a letter dated December 18, 2014, and subsequent
correspondence, submitted by Taxpayer, requesting a letter ruling that certain of
Taxpayer's depreciable tangible property used in its business activity is 7-year property
described in § 168(e)(3)(C)(v) of the Internal Revenue Code.

                                                     FACTS

         Taxpayer represents that the facts are as follows:

      Taxpayer, a State1 corporation, joins in the filing of a consolidated federal
income tax return headed by Parent. A, a State1 limited liability company, is a wholly-
owned subsidiary of Taxpayer. B, a State1 limited liability company, is a wholly-owned
subsidiary of A. Neither A nor B has elected to be classified as an association taxed as
a corporation for federal income tax purposes and, as a result, they are both
disregarded as entities separate from Taxpayer. Taxpayer, A, and B are not utilities.

       C, an unrelated third party, operates an electric grid transmission system in City
in State2. The grid transmits electricity produced by power generation facilities that
supply energy to the C service territory. This electric system must maintain a grid
frequency of 60 hertz to operate safely and efficiently. There are several companies
providing frequency regulation services to C to maintain the grid frequency of 60 hertz.
Because there is more frequency regulation service available to C than C requires at
any given time, C selects which companies to employ for frequency regulation services
using a bidding system.
PLR-101737-15                                  3

      B owns and operates a Storage Device whose primary purpose is to provide
frequency regulation services to C. B has provided such services to C since Date1.
Because A and B are disregarded entities for federal tax purposes, Taxpayer is deemed
to own this Storage Device for federal tax purposes.

       The Storage Device could be located anywhere on C’s grid. The Storage Device
happens to be attached to a E kilovolt electrical distribution feeder line that belongs to
D, a utility. This distribution feeder line is located adjacent to D’s substation near City in
State2.

       The Storage Device consists of F Units. These Units are held in a shipping
container that is connected to a combiner box that holds transformers that in turn is
connected to the grid by G cables. Each Unit can operate at a rated capacity of up to H
kilowatts, providing an aggregate total rated capacity of I megawatts. Each Unit can
operate independently.

        Taxpayer (through A and B) primarily uses the Storage Device near City in
State2 to provide frequency regulation services to C by removing electricity from C’s
grid when its frequency is high, temporarily storing that electricity, and releasing the
electricity back onto the grid when its frequency is low. The electricity is removed and
released at the exact same point on C’s grid. Although the Storage Device eventually
releases almost all of the electricity back onto the grid, a small amount of electricity is
lost while the electricity is held in the Storage Device. The majority of this electricity is
lost when it escapes the Storage Device as heat. To account for this loss, C charges
Taxpayer (through A and B) for the electricity that the Storage Device removes from the
grid, and pays Taxpayer (through A and B) for the electricity that the Storage Device
releases onto the grid. In both cases, Taxpayer (through A and B) and C pay wholesale
prices for the electricity, which varies from hour to hour. Taxpayer (through A and B)
does not anticipate making any significant profit or suffering any significant loss from
this exchange of electricity. When electricity is moved from the grid to the Storage
Device, ownership of that electricity shifts to Taxpayer (through A and B), and when the
electricity is released back onto the grid, ownership is transferred back to C. All
transfers of ownership occur at a revenue meter.

        By letter dated May 5, 2015, Taxpayer represents that, from Date1 to Date2, all
of B’s revenue came from C’s payments for B providing frequency regulation services to
C by using the Storage Device near City in State2. B did not realize any income from
the sale of electricity back to C (when taking into account the cost of such electricity).
Because the Storage Device loses a small amount of the electricity that it stores, B
actually spent more money to purchase electricity from C than it realized from selling
electricity back to C.
PLR-101737-15                                 4



                                  RULING REQUESTED

       Taxpayer requests the Internal Revenue Service issue the following ruling:

The Storage Device primarily used by Taxpayer to provide frequency regulation
services is property with no class life under § 168 and, as a result, is 7-year property
under § 168(e)(3)(C)(v).

                                  LAW AND ANALYSIS

       Section 167(a) provides that there is allowed as a depreciation deduction a
reasonable allowance for the exhaustion, wear and tear, and obsolescence of property
used in a trade or business or held for the production of income.

       The depreciation deduction provided by § 167(a) for tangible property placed in
service after 1986 generally is determined under § 168, which prescribes two methods
for determining depreciation allowances: (1) the general depreciation system in
§ 168(a); and (2) the alternative depreciation system in § 168(g). Under either
depreciation system, a taxpayer computes the depreciation deduction by using a
prescribed depreciation method, recovery period, and convention.

        For purposes of § 168(a), the depreciation method, recovery period, and
convention are determined by the property’s classification under § 168(e). Pursuant to
§ 168(e)(1), property with a class life of 4 years or less is classified as 3-year property,
property with a class life of more than 4 years but less than 10 years is classified as 5-
year property, property with a class life of 10 years or more but less than 16 years is
classified as 7-year property, property with a class life of 16 years or more but less than
20 years is classified as 10-year property, property with a class life of 20 years or more
but less than 25 years is classified as 15-year property, and property with a class life of
25 years or more is classified as 20-year property.

       Section 168(i)(1) defines the term "class life" as meaning the class life (if any)
that would be applicable with respect to any property as of January 1, 1986, under
former § 167(m) as if it were in effect and the taxpayer were an elector. Former
§ 167(m) provided that in the case of a taxpayer who elected the asset depreciation
range system of depreciation, the depreciation deduction would be computed based on
the class life prescribed by the Secretary which reasonably reflected the anticipated
useful life of that class of property to the industry or other group.

       Section 1.167(a)-11(b)(4)(iii)(b) of the Income Tax Regulations sets out the
method for asset classification under former § 167(m). Property is included in the asset
guideline class for the activity in which the property is primarily used. Property is
PLR-101737-15                                 5

classified according to primary use even though the use is insubstantial in relation to all
of the taxpayer's activities.

        Rev. Proc. 87-56, 1987-2 C.B. 674, sets forth the class lives of property that are
necessary to compute the depreciation allowances under § 168. This revenue
procedure establishes two broad categories of depreciable assets: (1) asset classes
00.11 through 00.4 that consist of specific assets used in all business activities; and (2)
asset classes 01.1 through 80.0 that consist of assets used in specific business
activities. The same item of depreciable property can be described in both an asset
category (that is, asset classes 00.11 through 00.4) and an activity category (that is,
asset classes 01.1 through 80.0), in which case the item is classified in the asset
category. See Norwest Corporation & Subsidiaries v. Commissioner, 111 T.C. 105
(1998) (item described in both an asset and an activity category (furniture and fixtures)
should be placed in the asset category). Unless otherwise noted, the business activity
asset classes described below are set forth in Rev. Proc. 87-56.

      If there is not an asset class of Rev. Proc. 87-56 that describes the property or
the business activity in which the property is primarily used and if the property is not
otherwise classified under § 168(e)(2) or (3), the property is 7-year property pursuant to
§ 168(e)(3)(C)(v).

       The first issue is whether any of the asset classes 00.11 through 00.4 of Rev.
Proc. 87-56 includes the Storage Device. Of these asset classes, only asset class 00.4,
Industrial Steam and Electric Generation and/or Distribution Systems, describes
property involving electricity.

        Asset class 00.4 of Rev. Proc. 87-56 includes assets, whether such assets are
§ 1245 property or § 1250 property, providing such assets are depreciable, used in the
production and/or distribution of electricity with rated total capacity in excess of 500
Kilowatts and/or assets used in the production and/or distribution of steam with rated
total capacity in excess of 12,500 pounds per hour for use by the taxpayer in its
industrial manufacturing process or plant activity and not ordinarily available for sale to
others. Assets in this class have a class life of 22 years and, as a result, are classified
as 15-year property under § 168(e)(1).

        In this case, the Storage Device is primarily used by Taxpayer to provide
frequency regulation services to C. The Storage Device is not used by Taxpayer in its
industrial manufacturing process or plant activity. Further, the Storage Device does not
produce electricity and, for the reasons stated below, is not used in the distribution of
electricity. Accordingly, the Storage Device is not property described in asset class
00.4. Consequently, none of the asset classes 00.11 through 00.4 of Rev. Proc. 87-56
describes the Storage Device.
PLR-101737-15                                   6

       The second issue is whether any of the asset classes 01.1 through 80.0 of Rev.
Proc. 87-56 describes Taxpayer's business activity of providing frequency regulation
services.

       There are two asset classes that may apply to Taxpayer's business activity: asset
class 49.14, Electric Utility Transmission and Distribution Plant, or asset class 57.0,
Distributive Trades and Services.

       Asset class 49.14 of Rev. Proc. 87-56 includes assets used in the transmission
and distribution of electricity for sale and related land improvements. This asset class
excludes initial clearing and grading land improvements as specified in Rev. Rul. 72-
403, 1972-2 C.B. 102. Assets in this class have a class life of 30 years and, as a result,
are classified as 20-year property under § 168(e)(1).

        The Tax Court in PPL Corporation v. Commissioner, 135 T.C. 176 (2010),
concluded that street light assets are not assets used in the distribution of electricity
and, thus, not included in asset class 49.14 of Rev. Proc. 87-56. In reaching its
conclusion, the Court looked at the definition of the word “distribution” as well as the
primary use of the street light assets. The parties stipulated that distribution meant “the
delivery of electric energy to customers” and “the final utility step in the provision of
electric service to customers." The Court found this definition to be consistent with a
standard definition of distribution. 135 T.C. at 183. The Court also stated that the
“distribution of electricity seems to us to be the process by which electricity (the
commodity) gets to final consumers.” Id. The Court found that street light assets could
be disconnected from the distribution system without effecting electrical distribution to
customers and they are distinct from distribution assets because they have a different
purpose and function. On this last point, the Court found that distribution assets get
final consumers electricity, service drops are the final part of the distribution of electricity
to final consumers, and street light assets are not part of the service to get electricity to
final consumers.

       The transmission of electricity is “the process of moving high voltage electricity
from power plants to distribution substations.” PPL Corporation, 135 T.C. at 178.
Transmission is defined by the U.S. Energy Information Administration (EIA) and the
North America Electric Reliability Corporation (NERC) as ‘”[a]n interconnected group of
lines and associated equipment for the movement or transfer of electric energy between
points of supply and points at which it is transformed for delivery to customers or is
delivered to other electric systems.” EIA’s Glossary at www.eia.gov/glossary.index.cfm
and Glossary of Terms Used in NERC Reliability Standards (updated May 19, 2015) at
www.nerc.com/files/glossary_of_terms.pdf.

      As mentioned under the first issue, the Storage Device is primarily used by
Taxpayer to provide frequency regulation services to C. As a result, the Storage Device
has a different purpose and function than electricity transmission and distribution
PLR-101737-15                                7

assets. If C does not use Taxpayer’s Storage Device on a given day, the transmission
of electricity is not affected because there are other companies providing frequency
regulation services to C. Although the Storage Device is used to store electricity to be
sold to C at a later time, we do not view the Storage Device as transmission or
distribution equipment. Accordingly, Taxpayer's business activity of providing frequency
regulation services to an unrelated third party is not described in asset class 49.14.

       Asset class 57.0 of Rev. Proc. 87-56 includes assets used in wholesale and retail
trade, and personal and professional services. Assets in this class have a class life of 9
years and, as a result, are classified as 5-year property under § 168(e)(1).

      Asset class 57.0 was established by Rev. Proc. 80-15, 1980-1 C.B. 618,
modifying Rev. Proc. 77-10, 1977-1 C.B. 548, and is derived, in part, from asset classes
50.0 (Wholesale and Retail Trade) and 70.2 (Personal and Professional Services) of
Rev. Proc. 77-10.

        Asset class 50.0 of Rev. Proc. 77-10 included: (1) assets used in carrying out the
activities of purchasing, assembling, storing, sorting, grading, and selling of goods at
both the wholesale and retail level, and (2) assets used in such activities as the
operation of restaurants, cafes, coin-operated dispensing machines, and in brokerage of
scrap metal.

       Asset class 70.2 of Rev. Proc. 77-10 included: (1) assets used in the provision of
personal services such as those offered by hotels and motels, laundry and dry cleaning
establishments, beauty and barber shops, photographic studios and mortuaries;
(2) assets used in the provision of professional services such as those offered by
doctors, dentists, lawyers, accountants, architects, engineers, and veterinarians;
(3) assets used in the provision of repair and maintenance services and those assets
used in providing fire and burglary protection services; and (4) equipment or facilities
used by cemetery organizations, news agencies, teletype wire services, frozen food
lockers, and research laboratories.

       In this case, Taxpayer primarily uses the Storage Device to provide frequency
regulation services to C. Although Taxpayer does buy and sell electricity from and to C
at wholesale prices, these transactions are ancillary to providing frequency regulation
services. From Date1 to Date2, all of B’s revenue came from C’s payments for B
providing frequency regulation services to C by using the Storage Device, and B spent
more money to purchase electricity from C than it realized from selling electricity back to
C. Effectively, over this period, the electricity purchases and sales were a cost of
providing the frequency regulation services. Consequently, we do not view Taxpayer as
engaged in a wholesale trade or retail trade activity for purposes of asset class 57.0 of
Rev. Proc. 87-56.
PLR-101737-15                                8

       However, we believe that the frequency regulation services provided by
Taxpayer to an unrelated third party are of the type contemplated by asset class 57.0 of
Rev. Proc. 87-56. Accordingly, the Storage Device primarily used by Taxpayer to
provide frequency regulation services is included in asset class 57.0 and, consequently,
has a class life of 9 years.

 CONCLUSION

        Based solely on the facts and representations and the relevant law and analysis
set forth above, we conclude that the Storage Device primarily used by Taxpayer to
provide frequency regulation services is property included in asset class 57.0 of Rev.
Proc. 87-56 with a class life of 9 years and, as a result, is 5-year property under
§ 168(e)(1).

       Except as specifically set forth above, no opinion is expressed or implied
concerning the tax consequences of the facts described above under any other
provisions of the Code (including other subsections of § 168).

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

      In accordance with the power of attorney, we are sending a copy of this letter to
Taxpayer’s authorized representatives. We are also sending a copy of this letter to the
appropriate operating division director.


                                                 Sincerely,

                                                 Kathleen Reed

                                                 KATHLEEN REED
                                                 Chief, Branch 7
                                                 Office of Associate Chief Counsel
                                                 (Income Tax and Accounting)

Enclosures (2):
      copy of this letter
      copy for section 6110 purposes