Wind generators' grid-upgrade payments are capital contributions

Plain-English summary

An investor-owned utility agreed to upgrade its transmission system with payments from independent wind generators seeking greater delivery capacity and fewer curtailments. The utility would own the improvements, exclude their cost from rate base, and provide no transmission service to the generators, while limited auxiliary-power purchases were expected to remain below the five-percent threshold. The generators sold their electricity before it reached the grid and represented that they would capitalize the payments as 20-year intangible assets. The IRS found that the arrangement met the intertie safe harbor in Notice 2016-36. It ruled that the improvements and construction payments were not contributions in aid of construction under section 118(b) and were excluded from the utility's income as nonshareholder capital contributions under section 118(a). The utility was directed to follow the automatic accounting-method-change procedures applicable to the safe harbor.

Ruling snapshot

• Question: Are the wind generators' payments for utility-owned transmission upgrades excludable nonshareholder capital contributions rather than taxable construction aid?
• Outcome: approved
• Key authorities: IRC §§ 61 and 118; Notice 2016-36; Rev. Proc. 2016-29 § 15.16

Full text (IRS public release)

Internal Revenue Service                                         Department of the Treasury
                                                                 Washington, DC 20224

Number: 201726004                                                Third Party Communication: None
Release Date: 6/30/2017                                          Date of Communication: Not Applicable
Index Number: 118.01-04
                                                                 Person To Contact:
-------------------------                                        ----------------, ID No. ------------------
--------------------------------------------                     Telephone Number:
-------------------------------------------                      ----------------------
-------------------------------                                  Refer Reply To:
----------------------------                                     CC:PSI:B05
                                                                 PLR-130649-14
In Re:                                                           Date:
         ---------------------------------                       April 04, 2017
         -------------------------




Legend

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

Corp 1                     =         -----------------
--------------------------------------------------------------

Administrator 1            =        ------------------------------------------------------------------

Administrator 2            =        ------------------------------------

Agreement 1                =        ---------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------

Agreement 2                =        ---------------------------------------------------------------------------------
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Dear --------------:

       This letter responds to a request for a ruling dated August 1, 2014, and
subsequent correspondence submitted on behalf of Taxpayer by your authorized
representatives. Taxpayer requested a ruling that certain payments Taxpayer received
from ---- independent generators (“Generators”) are contributions to the capital of
Taxpayer under § 118(a) of the Internal Revenue Code. The relevant facts as
represented in your submission are set forth below.

                                                     FACTS
PLR-130649-14                                             2


         Taxpayer is an investor-owned utility that supplies natural gas to --------------
customers and electricity to -------------customers. Taxpayer is a corporation under -------
----------- law. Taxpayer is part of an affiliated group of corporations of which Corp 1 is
the common parent. Corp 1 files a consolidated federal income tax return for all
members of the affiliated group, including Taxpayer. Corp 1 uses a calendar tax year
and the accrual method of accounting.

       Taxpayer signed Agreement 1 and Agreement 2 (collectively, “Agreements”) with
Generators who collectively own ---- wind farms in --------------------------. Pursuant to
Agreements, Taxpayer will make certain upgrades to its transmission grid in exchange
for compensation from Generators. The payments under Agreements are being made
in an effort by Generators to increase the deliverability of their generation, avoid
curtailment, and prevent violations of operating limits on transmission equipment owned
by Taxpayer.

         Taxpayer transferred functional control of its transmission system to
Administrator 1, a regional transmission organization ("RTO") and independent system
operator that oversees the grid in portions of the ----------------------------------------------------
------------. The wind farms are connected either to Administrator 1 or a neighboring
RTO, Administrator 2. Administrator 2 coordinates the movement of electricity through
all or parts of --------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-----------------. Each generator has an interconnection agreement with a utility that is a
member of either Administrator 1 or Administrator 2. --------- of the wind farms
interconnect with ----------------------------------in Administrator 2. The other ------
interconnect with utilities in Administrator 1, ----- with ----------- and ----- with Taxpayer.

         Administrator 1 and Administrator 2 grids are joined to each other. The volume
of electricity being carried on a section of the Administrator 2 grid can lead to increased
flow or congestion on the Administrator 1 grid and vice versa. In a case when market
processes are not effective, Administrator 1 can notify Administrator 2 of the need for
Administrator 2 to curtail some generators on its system and vice versa when needed to
relieve congestion or prevent system operating limits from being exceeded. In ------------
-------, Administrator recommended upgrades to ------ -------- and -----------circuits on
Taxpayer’s system to increase the thermal limits and, in turn, reduce the potential for
limit violations in order to increase available capacity. Generators and Taxpayer then
entered into Agreements.

         Taxpayer agreed in Agreement 1 to re-conductor circuits running between its -----
-------------- ---------------------- substations and from the ----------------substation to a ---------
---------------line to increase the carrying capacity to -------------. Taxpayer also agreed to
re-conductor circuits from the ------------------------line to its -------------------substation and
from the -------------------substation to the --------------- substation to increase the capacity
PLR-130649-14                                      3

to -------------. Taxpayer agreed in Agreement 2 to install ----------------------conductors on
transmission towers and upgrade terminal equipment to increase the carrying capacity
of the circuits between its ----------------------------------------------------------to -------------.
Taxpayer also agreed to address a clearance issue with one transmission line and
reposition another line to operate the circuit at a higher operating temperature, resulting
in an increase to --------------between its -----------------------------------substations.

        Taxpayer does not provide transmission services to any of Generators. Two
generators directly interconnect with Taxpayer and buy auxiliary power from Taxpayer.
Auxiliary power purchased has historically accounted for and is anticipated to be well
under 5% of total power flows in both directions over each such generator's intertie.
Generators have represented to Taxpayer that it sells the output from its wind farms to
customers at the point that the electricity exits the generating facility and before the
electricity reaches the grid.

        Taxpayer will own the transmission upgrades. Taxpayer will not add the amount
it spends on the capital costs of the upgrades into rate base and will not recover the
amount of the capital costs of the upgrades from its transmission customers through the
rates it charges. Generators have represented to Taxpayer that they will treat their
payments to Taxpayer as basis in intangible assets and recover the amounts for tax
purposes on a straight-line basis over 20 years.

                                      RULING REQUESTED

       Taxpayer requests a ruling that the contribution of the intertie, and all sums paid
for construction of the intertie are not a contribution in aid of construction (CIAC) under
§ 118(b), and are excludable from Taxpayer's gross income as a non-shareholder
contribution to capital under § 118(a).

                                      LAW AND ANALYSIS

      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.

       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
PLR-130649-14                                   4

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.

       Notice 2016-36, 2016-36 provides a safe harbor for transfers of property from
either an electricity generation or cogeneration facility or an energy storage facility to a
regulated public utility, used to facilitate the transmission of electricity over the utility’s
transmission system, to be treated as a contribution to the capital of a corporation under
§ 118(a), and not a contribution in aid of construction (CIAC) under § 118(b).

         The safe harbor provides that a contribution of an intertie, including a dual-use
intertie, by a generator to a utility will not be treated as gross income under § 118(a) or
a CIAC under § 118(b) if all of the following conditions are met. First, the generator may
not purchase electricity from the utility, unless the purchase satisfies the 5% test. The
5% test provides that if, in light of all information available to the utility at the time the
intertie is contributed, it is reasonably projected that, during the ten taxable years of the
utility beginning with the year in which the contributed intertie is placed in service, no
more than 5% of the projected total power flows over the intertie will flow to the
generator, the 5% test will be satisfied. This projection must be supported by
appropriate documentation. Total power flows mean power flows to or from the
generator over the intertie. Power flows to a generator include power flows to a related
party of the generator, if the transmission of power to the related party has been
facilitated by the contribution of the intertie. For purposes of the 5% test, power flows in
the taxable year in which the transferred property is placed in service may, at the option
of the utility, be ignored. Power purchases by the generator from parties other than the
utility are not taken into account.

        Second, in the case of electricity wheeled over the utility’s transmission system,
ownership of the wheeled electricity remains with the generator prior to its transmission
onto the grid. This ownership requirement is deemed to be satisfied if title to electricity
wheeled passes to the purchaser at the busbar on the generator's end of the intertie.
Third, the cost of the intertie is not included in the utility’s rate base. Fourth, the intertie
will be used for transmitting electricity. Finally, the cost of the intertie is capitalized by
the generator as an intangible asset and recovered using the straight-line method over
a useful life that is treated as 20 years. A utility may not claim depreciation (or
PLR-130649-14                                  5

amortization) deductions with respect to the intertie. However, if the intertie is
subsequently transferred or deemed transferred to the utility, the utility may be allowed
to take depreciation deductions with respect to the intertie.

         Section VIII of Notice 2016-36 provides that the IRS will not issue private letter
rulings involving the safe harbor under Notice 2016-36. Further, section 6.09 of Rev.
Proc. 2017-1, 2017-1 I.R.B. 1, provides that generally, the Service will not issue a letter
ruling or a determination letter if the request presents an issue that cannot be readily
resolved before a regulation or any other published guidance is issued. Section
3.01(24) of Rev. Proc. 2017-3 provides that the Service will not issue rulings or
determination letters concerning whether a transfer of an intertie, as defined in section
III. B. 2. of Notice 2016–36 meets all of the requirements under the safe harbor provided
by Notice 2016–36. In this case, Taxpayer requested the private letter ruling before the
project that led to publication of Notice 2016-36 was opened and before the addition of
this area to Rev. Proc. 2017-3. In the interest of sound tax administration and because
the circumstances of this particular case warrant the issuance of a private letter ruling,
we are issuing this private letter ruling.

       In the instant case, the transfer of the intertie is subject to the guidance set forth
in Notice 2016-36, and we conclude that the deemed contribution of the intertie by
Generators to Taxpayer meets the safe harbor requirements of Notice 2016-36.
Therefore, the deemed contribution of the intertie to Taxpayer, and all sums paid for
construction of the intertie are not a CIAC under § 118(b), and are excludable from
Taxpayer's gross income as a non-shareholder contribution to capital under § 118(a).

        A change in a utility’s treatment of a transfer of an intertie, including a change to
or from the safe harbor method of accounting provided in section III of Notice 2016-36,
is a change in method of accounting to which the provisions of §§ 446 and 481 and the
regulations thereunder apply. A utility that wants to change to the methods of
accounting described in this notice must use the automatic change procedures in Rev.
Proc. 2015-13, 2015-5 I.R.B. 419, or its successor. Taxpayer should follow the
instructions under section 15.16 of Rev. Proc. 2016-29, 2016-21 I.R.B. 880 with respect
to the transaction described in this letter ruling.

      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.

      This ruling is based upon information and representations submitted by the
taxpayer and accompanied by a penalty of perjury statement executed by an
PLR-130649-14                                             6

appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

         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,



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

Enclosure: 6110 copy

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