How do the transitional depreciation rules apply to a utility's or power producer's depreciable property held under a synthetic lease?

Plain-English summary

KeySpan Corporation and Affiliates, parent of utility and energy companies, owned depreciable assets subject to the transitional depreciation rules of Tax Law section 208.9(c-2) and (c-3) (added by Chapter 63 of the Laws of 2000) and placed them under "synthetic leases" -- off-balance-sheet financings in which, for federal income tax purposes, the lessee is treated as the owner. It asked how those transition rules apply to the synthetically leased property.

The Department held:

• Because the synthetic lessee has the depreciable interest (treated as owner federally), the property meets the "transition property" requirement, and the lessee applies the transition rules -- the synthetic structure does not make it the GAAP owner, but it is treated as owner for depreciation.
• A qualified public utility (section 208.9(c-2)) must add back its federal section 167 depreciation and take a New York depreciation deduction computed as if GAAP depreciation rules applied to the transition property.
• A qualified power producer (section 208.9(c-3)) must likewise add back federal depreciation and take a New York deduction computed on the property as a single asset: derive the January 1, 2000 net book value (cost minus GAAP-style accumulated depreciation) and depreciate using straight-line, a 20-year life, and zero salvage value.
• It does not matter whether the taxpayer actually maintains GAAP reports, but it must keep books and records documenting the application of the transition rules.

What this means for you

A synthetic lessee is the "owner" for these depreciation rules

If a utility or power producer holds transition property through a synthetic lease (federally treated as owning it), the transitional depreciation rules apply to it. The financing form does not move the depreciation off its New York return.

Add back federal depreciation, take a New York deduction

For Article 9-A, you add back the federal section 167 depreciation and substitute a New York deduction: a utility computes it as if GAAP depreciation applied; a power producer uses a single-asset, straight-line, 20-year, zero-salvage method on January 1, 2000 net book value.

Keep transition-rule books even without GAAP statements

Whether or not you actually issue GAAP financial statements, you must maintain books and records showing how you applied the section 208.9(c-2)/(c-3) transition rules.

Common questions

Q: Do the transitional depreciation rules apply to synthetically leased property?
A: Yes. The synthetic lessee is treated as owning the transition property, so the rules apply to the utility or power producer.

Q: How is the New York depreciation deduction computed?
A: Add back federal section 167 depreciation; a qualified public utility uses an as-if-GAAP method, and a qualified power producer uses single-asset straight-line, 20-year life, zero salvage on net book value.

Q: Does it matter whether the taxpayer keeps GAAP statements?
A: No, but it must maintain books and records documenting its application of the transition rules.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 208.9(c-2) (transitional depreciation adjustments for qualified public utilities)
- Tax Law section 208.9(c-3) (transitional depreciation adjustments for qualified power producers)
- Chapter 63 of the Laws of 2000
- Internal Revenue Code section 167 (depreciation)
- KeySpan Corporation and Affiliates, TSB-A-02(13)C (July 9, 2002)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_2002.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a02_13c.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-02(13)C
Corporation Tax
July 9, 2002

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C010810A

On August 10, 2001, a Petition for Advisory Opinion was received from KeySpan
Corporation and Affiliates, 1 MetroTech Center, Attn: Paul Wright, Brooklyn, New York, 11201.
The issue raised by Petitioner, KeySpan Corporation and Affiliates, is the application of
sections 208.9(c-2)(3) and (4), and 208.9(c-3)(3) and (4) of Article 9-A of the Tax Law to
depreciable property that is the subject of a “synthetic lease” financing transaction.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner is the parent of a group of calendar year corporations engaged in various utility
and energy related businesses. One or more of Petitioner and its subsidiary corporations was a
regulated utility or an independent power producer that owned depreciable assets that were made
subject to the transitional depreciation rules contained in sections 208.9(c-2)(3) and (4) and 208.9(c­
3)(3) and (4) of the Tax Law as added by Chapter 63 of the Laws of 2000.
The regulated utility and independent power producers enter into synthetic leases with
respect to the depreciable assets that are subject to the transitional depreciation rules. Petitioner
states that a synthetic lease is an off-balance sheet financing transaction between a borrower/lessee
(the regulated utility or independent power producer), and a lender/lessor (generally a trust affiliated
with financial sector lending institutions). The items of property subject to the synthetic lease in this
case are depreciable assets subject to the transitional depreciation rules. Synthetic lease transactions
have three core components:
1. In form, the borrower is not a borrower but a lessee under a lease, with options and
obligations to purchase the leased asset at the expiration of the lease term. A variety of
contractual indemnities, obligations and responsibilities are put in place to vest in the
synthetic lessee the economic indicia of ownership of the leased asset.
2. For federal income tax purposes, the synthetic lessee is treated as owning the leased asset.
The lease is recharacterized for federal income tax purposes as a financing between the
lessee, as borrower, and the lessor, as lender. The lessee thus files its federal income tax
returns consistent with the proposition that it owns the asset and owes money to the lessor
under a (secured) borrowing; and the lessor treats itself as a lender, receiving debt service
payments of principal and interest, not rent.
3. Under generally accepted accounting principles (“GAAP”), the synthetic lease qualifies
as an “operating lease.” Consequently, the GAAP based financial statements of the synthetic

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lessee show the lessee as paying rent. Its GAAP financial reports do not show the lessee as
owning or depreciating the leased asset, nor do they show it as owing the amounts due under
the financing.
A lessee’s GAAP treatment of synthetically leased assets thus is effectively the opposite of
the federal income tax treatment. The synthetic lessee claims depreciation for federal income tax
purposes under section 167 of the Internal Revenue Code (“IRC”), but does not report the asset, or
any depreciation, on its GAAP financial reports. The lessor does not claim any depreciation
deduction with respect to the synthetic leased property for federal income tax purposes.
Discussion
Section 208.9 of the Tax law defines entire net income as "total net income from all sources,
which shall be presumably the same as the entire taxable income ... which the taxpayer is required
to report to the United States treasury department ... except as hereinafter provided...." Therefore,
the taxable income reported for federal income tax purposes is the starting point for computing entire
net income. After determining federal taxable income, it must be adjusted as required by section
208.9 of the Tax Law.
Section 208.9(c-2) of the Tax Law provides for adjustments in computing entire net income
for qualified public utilities. A “qualified public utility” means a taxpayer that was subject to the
ratemaking supervision of the New York State Department of Public Service (“PSC”) on
December 31, 1999, and for the year ending on December 31, 1999, was subject to tax under former
section 186 of Article 9 of the Tax Law.
Section 208.9(c-2)(2)(B) of the Tax Law provides that the term “transition property” means
property placed in service by a qualified public utility before January 1, 2000, for which a
depreciation deduction is allowed under section 167 of the IRC.
Section 208.9(c-2)(3) of the Tax Law provides that with respect to transition property of a
qualified public utility, the deduction for depreciation under section 167 of the IRC is not allowed.
Section 208.9(c-2)(4) of the Tax Law provides that with respect to transition property, a deduction
is allowed for the depreciation expense shown on the books and records of the taxpayer for the
taxable year and determined in accordance with generally accepted accounting principles.
Section 208.9(c-3) of the Tax Law provides for depreciation adjustments by qualified power
producers and pipeline companies. A “qualified power producer” means a taxpayer that was not
subject to the ratemaking supervision of the PSC on December 31, 1999, and for the year ending on
December 31, 1999, was subject to tax under former section 186 of Article 9 of the Tax Law on
account of its being principally engaged in the business of supplying electricity.

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Section 208.9(c-3)(2)(D) of the Tax Law provides that the term “transition property” means
property placed in service by a qualified power producer before January 1, 2000, for which a
depreciation deduction is allowed under section 167 of the IRC.
Section 208.9(c-3)(3) of the Tax Law provides that with respect to transition property of a
qualified power producer, the deduction for depreciation under section 167 of the IRC is not
allowed.
Section 208.9(c-3)(4) of the Tax Law provides that with respect to transition property, a
deduction for depreciation expense is allowed, and is computed as follows:
(1) All transition property shown on the books and records of the taxpayer
on January 1, 2000 is treated as a single asset placed in service on such date. The
New York basis for purposes of computing the depreciation deduction on such single
asset is the net book value of such transition property determined on the first day of
the federal taxable year ending in 2000 (or on the date any such property is placed
in service, if later), and if the transition property is sold or otherwise disposed of, the
New York basis of the single asset is reduced on the date of such sale or disposition
by the amount of the adjusted federal tax basis of such property on such date. The
“net book value” means cost reduced by accumulated depreciation shown on the
books and records of the taxpayer and determined, in the case of a qualified power
producer, in accordance with GAAP.
(2) The New York depreciation deduction allowed for any taxable year with
respect to such single asset shall be computed using the straight-line method, a
twenty-year life and a salvage value of zero.
Department of Taxation and Finance Important Notice, N-00-18, August 24, 2000, provides
that for purposes of section 208.9(c-3)(4) of the Tax Law, when a fiscal year taxpayer computes its
deduction for New York depreciation expense, it treats all of its transition property shown on its
books and records on January 1, 2000 as a single asset placed in service on the first day of the
federal taxable year that ends in 2000.
For federal income tax purposes, the synthetic lessee has a depreciable interest in the leased
property. A qualified public utility and a qualified power producer are allowed a deduction for
depreciation under section 167 of the IRC with respect to such synthetically leased transition
property. Thus, the condition for the application of the transition rules under sections
208.9(c-2)(2)(B) and 208.9(c-3)(2)(D) of the Tax Law, respectively, is met, and the depreciation
deduction allowed for federal income tax purposes with respect to such transition property is
disallowed in computing the entire net income of a qualified public utility or a qualified power
producer, respectively.

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Next, it is necessary to determine the amount of the New York depreciation deduction for
depreciation expense that a qualified public utility or a qualified power producer, respectively, is
allowed on the synthetically leased transition property under the transition rules in sections
208.9(c-2)(4) and 208.9(c-3)(4) of the Tax Law, respectively. Where a qualified public utility or
a qualified power producer is treated for federal income tax purposes as owning synthetically leased
transition property, such qualified public utility or qualified power producer, respectively, is also
treated as having a depreciable interest in such synthetically leased transition assets under sections
208.9(c-2)(4) and 208.9(c-3)(4) of the Tax Law, respectively, without regard to the GAAP
ownership rules.
Therefore, the amount of the New York depreciation deduction for depreciation expense that
a qualified public utility is allowed with respect to such synthetically leased transition property is
determined by applying the GAAP provisions referenced in the transition rules in section
208.9(c-2)(4) of the Tax Law, “as if” the qualified public utility were the GAAP owner of the
transition property. That is, the GAAP rules for determining the “amount” (e.g., useful life, salvage
value, cost recovery methods) of the New York depreciation deduction for depreciation expense
allowable for transition property are applied to a qualified public utility’s synthetically leased assets,
without regard to the fact that the GAAP “ownership” rules do not treat the qualified public utility
as the owner of such assets.
Likewise, the amount of the New York depreciation deduction for depreciation expense that
a qualified power producer is allowed with respect to synthetically leased transition property is
determined by applying the GAAP provisions referenced in the transition rules in section
208.9(c-3)(4) of the Tax Law “as if” the qualified power producer were the GAAP owner of the
transition property. That is, the GAAP rules for determining the “net book value” of the transition
property, which is treated as a single asset for purposes of computing the New York depreciation
deduction for depreciation expense allowable for such transition property, are applied to a qualified
power producer’s synthetically leased assets, without regard to the fact that the GAAP “ownership”
rules do not treat the qualified power producer as the owner of such assets.
Conclusion
Under the transition rules in section 208.9(c-2) of the Tax Law, a qualified public utility is
required to add back its deduction for federal depreciation allowed under section 167 of the IRC on
its synthetically leased transition property, and is then allowed, for purposes of Article 9-A of the
Tax Law, to take a New York depreciation deduction for depreciation expense on such property
determined in accordance with the depreciation methodologies established under GAAP. The
qualified public utility must calculate the amount of such deduction for depreciation expense that
is allowed in each taxable year under section 208.9(c-2)(4) of the Tax Law, as if the GAAP
depreciation rules applied to its transition property.

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Under the transition rules in section 208.9(c-3) of the Tax Law, a qualified power producer
is required to add back its deduction for federal depreciation allowed under section 167 of the IRC
on its synthetically leased transition property, and is then allowed, for purposes of Article 9-A of the
Tax Law, to take a New York depreciation deduction for depreciation expense on such property
determined under section 208.9(c-3)(4) of the Tax Law on the basis of transition property treated
as a single asset. The qualified power producer must calculate the amount of the accumulated
depreciation that is to be subtracted from cost as if the GAAP depreciation rules applied to such
property, and thus derive the January 1, 2000 net book value, which is the New York basis for
purposes of computing the New York depreciation deduction for depreciation expense of its “single
asset” transition property. The qualified power producer must calculate the amount of such
deduction for depreciation expense that is allowed in each taxable year using net book value, the
straight-line depreciation method, a 20-year life, and a salvage value of zero.
In the calculation of a qualified public utility’s or a qualified power producer’s New York
depreciation deduction for depreciation expense allowed under Article 9-A of the Tax Law for
transition property, it does not matter whether the qualified public utility or the qualified power
producer in fact maintains GAAP financial reports, or whether a particular asset, or the depreciation
thereon is in fact reflected in the qualified public utility’s or qualified power producer’s GAAP
financial reports. However, the qualified public utility or the qualified power producer must
maintain a set of books and records to record the application of the transition rules under section
208.9(c-2) and (c-3) of the Tax Law.

DATED: July 9, 2002

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.