Market-priced solar systems are not public utility property

Plain-English summary

A regulated electric utility proposed a voluntary program under which it would own and operate solar systems at participating commercial customers' premises. Each customer would receive a percentage of the electricity generated in exchange for a negotiated monthly fee based on market factors and the customer's circumstances. Although state regulators approved the program, the systems' costs would not enter the regulated rate base and the customer fees would not be set on a cost-of-service or rate-of-return basis. The IRS ruled that the systems would not be public utility property under sections 168(i)(10) and former 46(f)(5). This matters because the tax normalization rules for public utility property would not apply to the systems on the facts presented.

Ruling snapshot

• Question: Are utility-owned solar systems offered at negotiated market prices public utility property under sections 168(i)(10) and former 46(f)(5)?
• Outcome: approved (the systems would not be public utility property)
• Key authorities: IRC §§ 46(f)(5), 50(d)(2), 167(l), 168(f)(2), 168(i)(10); Treas. Reg. §§ 1.46-3(g)(2), 1.167(l)-1

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 202017027                                               Third Party Communication: None
Release Date: 4/24/2020                                         Date of Communication: Not Applicable
Index Number: 168.24-00
                                                                Person To Contact:
--------------------------                                      ------------------------------, ID No. ------------
----------------------------------                              -----------------
-------------------------------                                 Telephone Number:
---------------------------                                     --------------------
                                                                Refer Reply To:
                                                                CC:PSI:B06
                                                                PLR-122204-19
                                                                Date:
                                                                January 23, 2020
Re: ---------------------------------------




LEGEND:

Taxpayer                   =         -----------------------------------------------------------
Company                    =         -------------------------------------------------------------
Commission A               =         ---------------------------------------------------
Commission B               =         ---------------------------------------------------------
State                      =         ----------
a                          =         -----
b                          =         ---
Date 1                     =         ---------------------------
Date 2                     =         -----------------
Director                   =         ---------------------------------------


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

       This letter responds to your request for a ruling, submitted by your authorized
representative, concerning the federal income tax consequences of the transaction
described below.

BACKGROUND and FACTS

      Company is a public utility organized and existing under the laws of State
engaged in the business of rendering electric utility service in State and owns, operates,
manages, and controls, among other things, plant and equipment in State used for the
production, transmission, delivery, and furnishing of electric service to its customers in

PLR-122204-19                                2

State. Company is subject to the regulatory jurisdiction of Commission A and
Commission B. Company is a wholly-owned indirect subsidiary of Taxpayer and a
member of its affiliated group which files a consolidated federal income tax return on a
calendar-year basis using the accrual method of accounting. For federal income tax
purposes, Company is a disregarded entity.

       On Date 1, Company filed a petition with Commission A, requesting approval of
the voluntary solar energy services program, (Program), as an Alternative Regulatory
Plan (ARP) under State law. In addition to seeking approval to use market derived
pricing for solar energy services under the Program, Company sought an ARP in order
to eliminate the need to file separate approval requests with Commission A for each
solar facility constructed under the Program.

       On Date 2, Commission A issued an order granting Company’s request to
implement the Program with some slight modifications. Under the order, the Company
is required to file an annual report with Commission A containing additional information
regarding the Program.

       Under the Program, the Company will enter into a solar energy service
agreement (Agreement) with a participating customer (Customer) for the provision of
solar energy services with respect to a solar photovoltaic generation system (System) to
be constructed and installed on the Customer’s premises. The Company will own,
operate, and maintain the System during the term of the Agreement. Pursuant to the
terms of the Agreement, the Customer is entitled to a percent of the electrical energy
generated by the System in exchange for a fixed monthly fee, which could include a
fixed percentage price escalator.

       Participation in the Program is voluntary and is limited to certain of the
Company’s commercial customers up to b megawatts of aggregate generating capacity.
None of the costs of the solar facilities installed under the Program will be included in
regulated rate base for purposes of determining the price for Solar Energy Service, or
otherwise.

       The Company will establish a market-based price for the solar energy services to
be paid by each Customer through arm’s-length negotiation, based on criteria that
include, but are not limited to, an evaluation of the Customer’s credit worthiness. Rates
charged to Customers under the Program will be based on market-based prices for the
particular solar facility that each participating Customer selects to match its individual
needs.

PLR-122204-19                                 3

RULING REQUESTED

       Taxpayer has requested a ruling that the System will not be public utility property
(PUP) within the meaning of § 168(i)(10) and former § 46(f)(5) of the Internal Revenue
Code (Code) because the prices negotiated under the Agreement and Program
approved by Commission A are not at a cost-of service based, rate-of-return price for
the furnishing of electrical energy.

LAW AND ANALYSIS

      Section 168(f)(2) of the 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 PUP, in relevant part, 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 PUP is
unchanged. Section 1.167(l)-1(b) provides that under § 167(l)(3)(A), property is PUP
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 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.

        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). Section
168(i)(l0) sets out the current definition of PUP for purposes of the depreciation
normalization rules.

      The definitions of PUP 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

PLR-122204-19                                 4

property will be considered PUP 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.

        The regulations under former § 46, specifically § 1.46-3(g)(2), contain an
expanded definition of regulated rates. This expanded definition embodies the notion of
rates established or approved on a rate of return basis. In addition, there is a 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 PUP is the same for purposes of
the investment tax credit and depreciation.

       Accordingly, the key factors in determining whether property is PUP are that (1)
the property must be used predominantly in the trade or business of the furnishing or
sale of, inter alia, electrical energy; (2) the rates for such furnishing or sale must be
established or approved by a State or political subdivision thereof, any agency or
instrumentality of the United States, or by a public service or public utility commission or
similar body of any State or political subdivision thereof; and (3) the rates so established
or approved must be determined on a rate-of-return basis.

         Any facility in the Program, described above, will be predominantly used in
 the trade or business of the furnishing or sale of electric energy and therefore, it
 will satisfy the first key factor. Moreover, as a regulated public utility subject to the
 ratemaking jurisdiction of Commission A and Commission B, approval of the
 Program satisfies the second factor. However, the fees charged to Customers
 under the Program are negotiated based on market-based factors as well as
 considerations unique to each particular Customer and not determined on a cost-of-
 service basis.

       Accordingly, we conclude that the System will not be PUP within the meaning of
§ 168(i)(10) and former § 46(f)(5).

       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

PLR-122204-19                                  5

service contract under § 7701(e). In addition, no opinion is expressed concerning
whether the Taxpayer is the owner of the System 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.

       This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
of the Code provides it may not be used 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. We are also sending a copy of this letter to the Director.


                                  Sincerely,



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




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