Market-rate solar facility is not public utility property

Plain-English summary

A regulated utility planned to invest in a partnership that would own a solar electric generating facility and sell most of its output to the utility under a wholesale power purchase agreement. The partnership would receive market-based rate authority, and the agreement's prices would be set at arm's length rather than through cost-of-service or regulated rate-of-return pricing. The IRS explained that electric property is public utility property for depreciation and investment-credit normalization only if it is used to furnish electricity, its rates are established or approved by an appropriate regulator, and those rates are determined on a rate-of-return basis. The facility met the first two requirements but not the third. The IRS therefore ruled that the facility was not public utility property under Section 168(i)(10) or former Section 46(f)(5), so its depreciation and investment tax credit were not subject to those normalization rules. The ruling did not decide whether the partnership would be respected or whether the power purchase agreement qualified as a service contract.

Ruling snapshot

• Question: Is the partnership-owned solar facility public utility property subject to depreciation and investment-credit normalization?
• Outcome: Approved, the facility is not public utility property
• Key authorities: IRC §§ 168(i)(10), 50(d)(2), 761(a), and 7701(e)(3); former IRC § 46(f)(5); Treas. Reg. §§ 1.46-3(g), 1.167(l)-1, and 1.761-2

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202140014                                              Third Party Communication: None
 Release Date: 10/8/2021                                        Date of Communication: Not Applicable
 Index Number: 168.24-00
                                                                Person To Contact:
 -------------------                                            ---------------, ID No. ------------
 ----------------------------                                   Telephone Number:
 ------------------------------                                 ---------------------
 ------------------------                                       Refer Reply To:
 -------------------------------                                CC:PSI:B06
                                                                PLR-128102-20
                                                                Date:
                                                                July 01, 2021

 In Re: ------------------------------




LEGEND:

Taxpayer                            =        ------------------------------
                                             ------------------------
Parent                              =        ------------------------------
                                             ------------------------
Commission A                        =        -------------------------------------------------
Commission B                        =        -----------------------------------------------------
Operator                            =        ------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------
State                               =        ------------
Agreement                           =        ------------------------------------------
Partnership                         =        -----------
Location                            =        -------------------------------------
a                                   =        -----
b                                   =        -----
c                                   =        ---
d                                   =        ---
Date 1                              =        ----------------
Year A                              =        -------
Director                            =        -----------------------------------------------------


Dear ----------

This letter responds to your request, dated November 30, 2020, for a ruling regarding
certain federal income tax consequences under § 168(i)(10) and former § 46(f)(5) of the
PLR-128102-20                                 2

Internal Revenue Code of the proposed transaction described below. The relevant facts
as represented in your submission are set forth below.

FACTS

Parent and Taxpayer, both State corporations, file a consolidated federal income tax
return on a calendar year basis with their affiliates. Taxpayer is a public utility engaged
principally in the generation and distribution of electricity and the distribution and
transportation of natural gas to retail customers in select markets in State.

Taxpayer is subject to regulation by Commission A and Commission B with respect to
the terms and condition of its services, including the rates it may charge for such
services. Taxpayer is also participated under an Agreement with Operator and is
subject to the terms and conditions of the Operator Tariff.

On Date 1, Taxpayer entered into a Build Transfer Agreement (BTA) with an
independent third party (Developer), via a wholly-owned special purpose entity
subsidiary (ProjectCo) to build an a Megawatt (MW) solar-powered electric generating
facility (Facility). Facility is to be located at Location and is expected to be placed in
service in Year A. Upon mechanical completion of the Facility, Taxpayer will sell its
membership interest in ProjectCo to Partnership. ProjectCo is a disregarded entity of
Partnership and Partnership will be the ultimate owner of Facility for Federal Tax
purposes.

Taxpayer and partners will each contribute cash to Partnership for the purposes of
purchasing Facility under the terms of an LLC agreement. Partnership will file for and
receive market-based authority from Commission B, allowing it to make any sales of
electricity, capacity, and ancillary services at market-based rates, rather than cost-
based rates with a regulated rate-of-return.

Partnership will use Facility to generate electricity and then sell the electricity to
Taxpayer under a wholesale power purchase agreement (PPA). The PPA will be
subject to separate approval by Commission B because Partnership will be an affiliate
of Taxpayer. All parties to the PPA will expressly agree that it should be treated as a
service contract under section 7701(e)(3) and that Taxpayer is a conduit for the delivery
of energy by Partnership into Operator’s markets.

Under the PPA Taxpayer will purchase b% of the electric output and capacity of the
Facility. The PPA will have a term of at least c years and will constitute a wholesale
contract under the jurisdiction of Commission B. Prices under the PPA will be
determined on an arm’s length, market basis pursuant to market-based rate authority
granted by Commission B and will not be determined on a rate-of-return basis or cost of
service basis.
PLR-128102-20                                   3

Taxpayer will acquire electricity from the wholesale electricity markets at market prices
as administered by Operator. The timing and volumes of purchased power will be
determined based on demand for power by Taxpayer’s customers in the normal course
of business operations and without regard to the timing and volumes of power sold by
Partnership.

As part of the proceedings with Commission A, Taxpayer is requesting that it be able to
include the cost of its investment in Partnership in rate base and that it be able to
recover the cost of its investment in Partnership ratably over d years.

Taxpayer expects that Facility will qualify for the Investment Tax Credit (ITC) provided in
§48. Profits, losses, cash, and ITCs of Partnership will be allocated in accordance with
the LLC agreement.

RULINGS REQUESTED

Taxpayer requested the following ruling:

The Facility will not be Public Utility Property Under section 168(i)(10), and therefore
related depreciation deductions and ITC will not be subject to the normalization rules of
section 168(i) or former section 46(f).

LAW AND ANALYSIS

Section 168(f)(2) 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) 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, by any agency or instrumentality of the United States, or by
a public service or public utility commission or other similar body of any State or political
subdivision thereof.

Prior to the Revenue Reconciliation Act of 1990, § 168(i)(10) defined public utility
property by means of a cross reference to § 167(l)(3)(A). Section 167(l)(3)(A) as then in
effect contained the same definition of public utility property that is currently in
§ 168(i)(10). 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
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
PLR-128102-20                                 4

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. Pursuant to § 50(d)(2), rules similar to the rules of former
§ 46(f), as in effect on November 5, 1990, continue to determine whether an asset is
public utility property for purposes of the investment tax credit normalization rules. As in
effect at that time, former § 46(f)(5) defined public utility property by reference to former
§ 46(c)(3)(B).

The regulations under former § 46 (of continuing applicability by virtue of § 50(d)(2)),
specifically § 1.46-3(g)(2)(iii), contains an expanded definition of regulated rates. This
expanded definition embodies the notion of rates established or approved on a rate of
return basis; where rate of return includes a fair return on the taxpayer’s investment in
providing such goods and services. Furthermore, rates are not “regulated” if they are
established or approved on the basis of maintaining competition within an industry,
insuring adequate service to customers of an industry, or charging “reasonable” rates
within an industry. In addition to the definition in the § 46 regulations, 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.

Thus, under both the depreciation and investment tax credit normalization rule
definitions, a facility must meet three requirements to be considered public utility
property:

   (1) It 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
PLR-128102-20                                 5


   (3) The rates so established or approved must be determined on a rate-of-return
       basis.

Section 761(a) of the Code defines the term ‘partnership’ and describes a type of
partnership that at the election of all members may exclude itself from partnership
treatment. A partnership not meeting such description may not elect to exclude itself
from partnership treatment.

Section 1.761-2(a)(3) of the regulations provides that eligibility for the election provided
by section 761(a) of the Code requires three principal elements. To the extent relevant,
this section provides that where the participants in the joint use of property (i) own the
property as coowners, (ii) reserve the right separately to take in kind or dispose of their
shares of any property produced, extracted, or used, and (iii) do not jointly sell services
or the property produced or extracted, then the unincorporated organization may elect
to be excluded from subchapter K of the Code.

Section 1.167(1)-3(c) of the regulations provides that if property held by a partnership is
not public utility property in the hands of the partnership, but would be public utility
property if an election were made under section 761 to be excluded from partnership
treatment, then section 167(1) shall be applied by treating the partners as directly
owning the property in proportion to their partnership interests.

Partnership will predominantly use the Facilities in the trade or business of the
furnishing or sale of electric energy. Therefore, the Facility will meet the first
requirement. In addition, Partnership will be under the jurisdiction of Commission B.
Therefore, the Facility will also meet the second requirement.

However, as described above, the rates charged by Partnership to Operator for
electricity to be produced by the Facility are determined under the market-based rate
authority of Commission B (not on a cost-of-service or rate-of-return basis).
Accordingly, we conclude that Facility owned by Partnership will not to be public utility
property within the meaning of § 168(i)(10) and former § 46(f)(5).

Except as explicitly 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, Taxpayer
has not requested a ruling regarding whether Partnership will be respected as a
partnership for federal income purposes nor provided partnership agreements for
Partnership. Accordingly, nothing in this letter should be construed as providing a ruling
or other determination that the Partnership will be respected as partnership or that any
purported owner will be respected as a partner for federal income tax purposes. In
addition, we express no opinion regarding whether the PPA will should be treated as a
service contract under § 7701(e)(3).
PLR-128102-20                                 6

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent. This ruling is based upon
information and representations submitted on behalf of Taxpayer and accompanied by
penalty of perjury statements executed by an appropriate party. While this office has
not verified any of the material submitted in support of the request for a ruling, 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. We are also sending a copy of this letter
to the Director.

                                       Sincerely,



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




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