Excludes a generator-funded utility intertie from income

Plain-English summary

A regulated electric utility asked how to treat an interconnection funded by an unrelated electricity generator. The generator needed the intertie to move power through the utility's system for sale to an unrelated purchaser, would reimburse all construction costs, and expected no more than five percent of power flows to run back to its facility. The utility would own and operate the intertie, keep its cost out of the rate base, and not treat the payment as compensation for electricity services. The IRS concluded that the arrangement met the safe harbor in Notice 2016-36. The contribution and construction payments therefore were not contributions in aid of construction under section 118(b) and were excluded from the utility's gross income as nonshareholder contributions to capital under section 118(a).

Ruling snapshot

• Question: Were the generator's intertie reimbursements excluded from the utility's income as nonshareholder capital contributions rather than taxable contributions in aid of construction?
• Outcome: Approved.
• Key authorities: IRC §§ 61 and 118; Treas. Reg. §§ 1.61-1 and 1.118-1; Notice 2016-36.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201813016
Release Date: 3/30/2018
Third Party Communication: None
Date of Communication: Not Applicable
Index Number: 118.01-02, 118.02-00

Person To Contact:
[redacted], ID No. [redacted]
Telephone Number:
[redacted]
Refer Reply To:
CC:PSI:B05
PLR-139447-14
Date:
December 15, 2017

In Re:
[redacted]

LEGEND

Taxpayer = [redacted]
Corp 1 = [redacted]
Generator = [redacted]
Facility = [redacted]
X = [redacted]
Power Purchaser = [redacted]
State = [redacted]

Dear [redacted]:

This letter responds to a request for a ruling dated October 20, 2014, and
subsequent correspondence submitted on behalf of Taxpayer by your authorized
representative. Taxpayer requests a ruling under § 118 of the Internal Revenue Code.
The relevant facts as represented in your submission are set forth below.

FACTS

Taxpayer, is a wholly owned subsidiary of Corp 1, and is located in State.
Taxpayer is a regulated electric utility company with electricity distribution and
transmission businesses. The distribution business consists primarily of the delivery,
purchase, and sale of electricity to customers within its franchise service territory. The
transmission business owns and maintains transmission facilities that are part of an
interstate power transmission grid.

PLR-139447-14 2

Generator is unrelated to Taxpayer. Generator owns and operates the Facility, a
qualified facility under the Public Utilities Regulatory Policies Act of 1978.

For Generator to wheel power produced by the Facility to Power Purchaser in
another state pursuant to a long-term power purchase contract, the Facility must
interconnect with the distribution lines of X and the distribution lines and transmission
grid of Taxpayer. Power Purchaser is unrelated to Generator, Taxpayer, and X.
Generator agreed to pay the costs to interconnect the Facility to the distribution lines of
X and the distribution lines and transmission grid of Taxpayer.

Taxpayer represents:

(a) The intertie contributed by Generator to Taxpayer will become a permanent part
of Taxpayer’s electric system;

(b) The proposed contribution is not compensation for electric supply services
provided by Taxpayer for Generator, but only represents reimbursement for the
intertie to allow Generator to move power onto the grid for sale to other unrelated
parties;

(c) Taxpayer will not include the costs of the intertie in its rate base; and

(d) Taxpayer will hold legal title to the intertie and operate the intertie as an integral
part of its electric system.

Generator represents:

(a) Generator will reimburse Taxpayer for all costs incurred in connection with the
intertie;

(b) Generator’s purpose for financing the intertie is so that Generator can gain
access to markets for the sale of electricity produced by the Facility;

(c) No part of the intertie is being made for the primary purpose to enable X or any
other utility to sell power to the Facility;

(d) Generator will depreciate its contribution for the intertie using 20-year straight line
depreciation; and

(e) The flow of power to the Facility from the grid in all years will not exceed 5% of
the total power flows over the intertie.

RULING REQUESTED

Taxpayer requests a ruling that the amounts paid by Generator to reimburse
Taxpayer for 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).

PLR-139447-14 3

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
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, 2016-25 I.R.B. 1029, 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.

PLR-139447-14 4

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
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
Generator 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,

PLR-139447-14 5

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 Taxpayer
and accompanied by a penalty of perjury statement executed by an 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 representative.

Sincerely,

NICOLE R. CIMINO
Chief, Branch 5
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosure:
Copy of this letter for § 6110 purposes

cc: