Wind facility is not public utility property, loss ruling declined

Plain-English summary

A regulated utility and a tax-equity investor planned a joint venture to acquire a wind facility and sell most of its electricity to the utility under a long-term wholesale power purchase agreement. Although the facility would generate electricity and operate under a regulator's jurisdiction, the agreement's prices would be set through competitive bidding on a market basis rather than a rate-of-return or cost basis. The IRS ruled that the facility therefore would not be public utility property under section 168(i)(10). The taxpayer also asked whether partnership losses allocated to the tax-equity investor would be allowed under section 707(b). The IRS declined to rule on that issue because it could not be readily resolved before further published guidance.

Ruling snapshot

• Question: Was the wind facility public utility property, and would losses allocated to the tax-equity investor survive section 707(b)?
• Outcome: Mixed: the facility is not public utility property; the IRS declined to rule on the loss issue.
• Key authorities: IRC §§ 168(i)(10) and 707(b); Treas. Reg. §§ 1.167(l)-1 and 1.46-3(g)(2); Rev. Proc. 2019-1 § 6.09.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201946007 Third Party Communication: None
Release Date: 11/15/2019 Date of Communication: Not Applicable
Index Number: 45.00-00 Person To Contact:
----------------------, ID No. -----------
Telephone Number:
----------------------------- --------------------
--------------------------- Refer Reply To:
------------------ CC:PSI:B06
----------------------------- PLR-101794-19
--------------------------------- Date:
August 08, 2019

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

LEGEND

Company = ------------------------------------------------------------------------
Taxpayer = ----------------------

State A = ------------
State B = ---------
a = -----
b = ---
County = -----------------------------
Date 1 = -----------------------
Date 2 = --------------------------
Date 3 = ----------------------
Year 1 = ------
Year 2 = ------
Year 3 = ------
Commission 1 = --------------------------------------------------
Commission 2 = -----------------------------------------------------
PLR-101794-19 2

Dear --- ----------

This is in response to your recent ruling request concerning the federal income tax
consequences with regard to the transaction described below.

BACKGROUND

Taxpayer, a State A corporation, is the parent company of a group of corporations (the
Group) that files a U.S. consolidated federal income tax return. The Group includes
members that are regulated natural gas and electric utility companies operating in
--------- states. The Group files a consolidated federal income tax return on a calendar
year basis using accrual methods of accounting.
Company is a State B limited liability company, wholly owned by Taxpayer, and treated
as a disregarded entity for U.S. federal income tax purposes. Company is regulated by
Commission 1 and participates in a wholesale energy market regulated by Commission

2. As part of its plan to replace a substantial portion of its coal-fueled electric
   generating fleet, Company intends to invest in and purchase electricity from wind
   projects. These wind projects are intended to qualify for the production tax credit (PTC)
   under § 45 of the Internal Revenue Code.

The Facility is located in County. It will have a nameplate capacity of approximately a
MW. The Facility is currently being developed by an independent third party developer
(Developer). The Facility is owned by Project LLC, a disregarded entity of Developer for
U.S. federal income tax purposes. On Date 1, Company entered into a Build Transfer
Agreement with Developer pursuant to which Developer will continue to develop the
Facility and sell it to Wind JV upon completion. The Facility is expected to be
completed before Date 2.

On or before Date 3, Company and an independent investor (Tax Equity Investor) will
enter into a joint venture by forming Wind JV LLC (Wind JV). Wind JV will purchase
from Developer all of the equity interests in Project LLC. Because Project LLC will be a
disregarded entity for U.S. federal income tax purposes, this transaction will be treated
as the sale and purchase of the Facility assets.

Wind JV will use the Facility to generate electricity to sell to Company under a
wholesale power purchase agreement (PPA). Under the PPA between Company and
Wind JV, Company will purchase a% of the electric output and capacity of the Facility.
The PPA will have a term of at least b years and will constitute a wholesale PPA under
the market-based rate authority of Commission 2. The structure of Wind JV and related
transactions, as well as the PPA, are also subject to approval by Commission 1. Prices
under the PPA will be determined on a market basis, using a competitive bidding
process, and will not be determined on a rate of return basis or cost basis.
PLR-101794-19 3

Company will also include the electricity purchased from Wind JV under the PPA as part
of its system power to provide electric service to Company’s retail customers.
Company’s sale of electricity to its retail customers will be subject to regulation by
Commission 1.

Based on the expected completion date, beginning in Year 1 and extending through
Year 2, Company will purchase a% of the electrical power produced by the Facility.
Accordingly, Company will make ongoing payments to Wind JV pursuant to the PPA.
Profits, losses, cash, and PTCs will all be allocated to Company and Tax Equity Investor
in accordance with the LLC Agreement.

In Year 3, Company will have an option to purchase all of Tax Equity Investor’s interests
in Wind JV for fair market value in accordance with the terms of the LLC Agreement. If
the option is exercised Company will then own a% of Wind JV.

In the hands of Wind JV, the electricity generated by the Facility will not be subject to
rate of return or cost basis regulation by Commission 1.

RULINGS REQUESTED

Rulings have been requested that:

(1) The Facility is not public utility property (or PUP) under § 168(i)(10).
(2) Any losses of Wind JV allocated to Tax Equity Investor will not be disallowed under
§707(b).

LAW AND ANALYSIS

Section 168(f)(2) of the Internal Revenue Code (Code) provides that the depreciation
deduction determined under § 168 shall not apply to any public utility property (within
the meaning of § 168(i)(10)) if the taxpayer does not use a normalization method of
accounting.

Section 168(i)(10) of the Code defines, in part, public utility property as property used
predominantly in the trade or business of the furnishing or sale of electrical energy if the
rates for such furnishing or sale, as the case may be, have been established or
approved by a State or political subdivision thereof.

Prior to the Revenue Reconciliation Act of 1990, the definition of public utility property
was contained in § 167(l)(3)(A) and § 168(i)(10), which defined public utility property by
means of a cross reference to § 167(l)(3)(A). The definition of public utility property is
unchanged. Section 1.167(l)-1(b) provides that under § 167(l)(3)(A), property is public
utility property during any period in which it is used predominantly in a § 167(l) public
utility activity. The term “section 167(l) public utility activity” means, in part, the trade or
business of the furnishing or sale of electrical energy if the rates for such furnishing or
PLR-101794-19 4

sale, as the case may be, are regulated, i.e., have been established or approved by a
regulatory body described in § 167(l)(3)(A). The term “regulatory body described in
section 167(l)(3)(A)” means a State (including the District of Columbia) or political
subdivision thereof, any agency or instrumentality of the United States, or a public
service or public utility commission or other body of any State or political subdivision
thereof similar to such a commission. The term “established or approved” includes the
filing of a schedule of rates with a regulatory body which has the power to approve such
rates, though such body has taken no action on the filed schedule or generally leaves
undisturbed rates filed by the taxpayer.

The definitions of public utility property contained in § 168(i)(10) and former § 46(f)(5)
are essentially identical. Section 1.167(l)-1(b) restates the statutory definition providing
that property will be considered public utility property if it is used predominantly in a
public utility activity and the rates are regulated. Section 1.167(l)-1(b)(1) provides that
rates are regulated for such purposes if they are established or approved by a
regulatory body. The terms established or approved are further defined to include the
filing of a schedule of rates with the regulatory body which has the power to approve
such rates even though the body has taken no action on the filed schedule or generally
leaves undisturbed rates filed.

Pursuant to Code §50(d)(2), rules similar to the rules of former Code §46(f) as in effect
on November 5, 1990, continue to determine whether or not an asset is PUP for
purposes of the investment tax credit normalization rules. As in effect at that time,
former Code §46(f)(5) defined PUP by reference to former Code § 46(c)(3)(B).

The regulations under former § 46, specifically § 1.46-3(g)(2), contain a definition of
regulated rates that is expanded somewhat from that contained in § 1.167(l)-1(b)(1).
This expanded definition embodies the notion of rates established or approved on a rate
of return basis. In addition, there is an expressed reference to rate of return in §
1.167(l)-1(h)(6)(i). The operative rules for normalizing timing differences relating to use
of different methods and periods of depreciation are only logical in the context of rate of
return regulation. The normalization method, which must be used for public utility
property to be eligible for the depreciation allowance available under § 168, is defined in
terms of the method the taxpayer uses in computing its tax expense for purposes of
establishing its cost of service for ratemaking purposes and reflecting operating results
in its regulated books of account. Therefore, for purposes of application of the
normalization rules, the definition of public utility property is the same for purposes of
the investment tax credit and depreciation.

Under both the depreciation and investment tax credit normalization rule
definitions, the property mu st be predominately used in one of a number of
enumerated activities. Aside from the description of certain telecommunications
services (which has no relevance to Taxpayer 's situation), the list of activities in
PLR-101794-19 5

the two definitions are virtually identical. One of these activities is the furnishing or
sale of electric energy.

There are, therefore, three characteristics all of which a facility must possess in
order to be characterized as PUP:

1. It must be predominately used in the trade or business of the furnishing or
   sale of electric energy;
2. The rates for such sale must be established or approved by one of the
   enumerated agencies or instrumentalities; and
3. The rates set by that agency or instrumentality must be established or
   approved on a rate-of-return basis.

The Facility will be predominantly used in the trade or business of the furnishing or sale
of electric energy, and therefore, it will possess the first of the three characteristics.
Moreover, as a regulated company subject to the jurisdiction of Commission 2, Wind JV
will possess the second of the three characteristics. However, Wind JV will use the
Facility to generate electricity to sell to Company under a wholesale PPA. The
wholesale PPA between Company and Wind JV will be regulated by Commission 2, but
prices under the PPA will be set at arm’s length pursuant to an RFP provided to
Company by Developer and under Commission 2 regulation will be determined on a
market basis and will not be determined on a rate of return basis or cost basis.
Because rates on the sale of electricity from the Facility will not be regulated by
Commission 2 on a rate of return basis, the Facility will not be PUP. Moreover,
Commission 1 will not have any jurisdiction over Wind JV or the Facility, and as a result,
could not influence the rates Company will pay for the electricity from the Facility.

Therefore, while the Facility will be used to produce electricity and will be subject to the
jurisdiction of Commission 2, and thus possesses the first two characteristics of PUP,
the Facility must possess all three characteristics to be considered PUP. For property
to be PUP, the electricity generated must be sold at rates that are regulated by a
government agency or public utility commission on a rate of return basis. Rates for the
sale by Wind JV of electricity generated by the Facility are determined on a market
basis and not on a rate of return or cost basis. Thus, the Facility is not PUP under §
168(i)(10).

With respect to the second issue, section 6.09 of Rev. Proc. 2019-1, 2019-1 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.

Accordingly, we conclude:

1. The Facility is not Public Utility Property under §168(i)(10).
   PLR-101794-19 6

2. The Service will not rule on the second issue based on § 6.09 of Rev. Proc. 2019-1.

Except as specifically determined above, no opinion is expressed or implied
concerning the Federal income tax consequences of the matters described above
under any other provisions of the Code (including other subsections of § 168).
Specifically, no opinion is expressed concerning whether the contract to sell electricity
constitutes a service contract under § 7701(e). In addition, no opinion is expressed
concerning whether the Taxpayer is the owner of the Facility generating electricity for
federal income tax purposes. Further, no opinion is expressed or implied on the
classification of the property under § 168(e). Except as provided in § 168(e)(3), section
5.03 of Rev. Proc. 87-56, 1987-2 C.B. 674, provides, however, that asset classes in
Rev. Proc. 87-56 include property described in such asset classes without regard to
whether a taxpayer is a regulated public utility or an unregulated company.

                              Sincerely,



                              Patrick S. Kirwan
                              Chief, Branch 6
                              Office of Associate Chief Counsel (Passthroughs &
                              Special Industries)