When a section 186 utility transfers its unregulated subsidiaries to its new holding company under a PSC restructuring, does that trigger gross earnings, gross income, or an excess dividend?

Plain-English summary

Rochester Gas and Electric (RG&E), taxed under sections 186 and 186-a, was reorganizing into a holding-company structure as the PSC required. Before the binding share exchange, it would transfer two unregulated subsidiaries (Energetix and RGS) up to the new Holding Company. RG&E asked whether that transfer triggers gross earnings (section 186), gross income (section 186-a), or an excess dividend (section 186).

Following Central Hudson and Con Ed, the Department held:

• Gross earnings (section 186) -- no. "Gross earnings" means receipts from the employment of capital. Restructuring an organization as compelled by the PSC is not employing capital, so transferring the subsidiaries (for no consideration) produces no gross earnings.
• Excess dividends tax (section 186) -- no. The transfer does not represent a distribution of the profits of RG&E (Adams Electric), so it is not a dividend subject to the excess dividends tax.
• Gross income (section 186-a) -- only if there is a profit. A PSC-supervised utility's section 186-a gross income includes profits from the sale of property. RG&E would have gross income only to the extent the subsidiaries' fair market value exceeds its book value. Because RG&E's basis equals or exceeds the subsidiaries' fair market value, there is no section 186-a gross income.

What this means for you

PSC-compelled restructuring does not employ capital

Steps a utility must take to comply with the PSC restructuring are not the employment of capital, so they do not generate section 186 gross earnings.

A mandated up-stream transfer is not a profit distribution

Moving subsidiaries to the new holding company under the mandate is not a distribution of profits, so it is not an excess-dividend dividend.

Section 186-a still reaches any actual gain

The gross income tax can apply, but only to a real profit -- fair market value over book value. Where basis meets or exceeds value, there is no gain to tax.

Common questions

Q: Does the mandated subsidiary transfer create section 186 gross earnings?
A: No. Restructuring as compelled by the PSC does not employ capital, so there are no gross earnings.

Q: Is it an excess dividend?
A: No. It is not a distribution of the utility's profits.

Q: Could section 186-a apply?
A: Only to the extent of a profit (fair market value over book value); here there is none because basis equals or exceeds value.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 186 (franchise tax; gross earnings; excess dividends tax)
- Tax Law section 186-a (gross income tax on utilities)
- Matter of Consolidated Edison Co. of NY v State Tax Commission, 24 NY2d 114
- People ex rel Adams Electric Light Co v Graves, 272 NY 77
- Central Hudson Gas & Electric Corporation, TSB-A-98(12)C (July 29, 1998)
- Rochester Gas and Electric Corporation, TSB-A-99(8)C (Jan. 27, 1999)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1999.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a99_8c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-99(8)C
Corporation Tax
January 27, 1999

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C981027C

On October 27, 1998, a Petition for Advisory Opinion was received from Rochester Gas and
Electric Corporation, 89 East Avenue, Rochester, New York 14649.
The issues raised by Petitioner, Rochester Gas and Electric Corporation, result from the
proposed corporate restructuring of Petitioner implemented in fulfillment of the New York State
Public Service Commission's mandate under its Competitive Opportunities proceeding. The specific
questions are:
Question 1 : Will Petitioner's transfer of the stock of Energetix and RGS to Holding Company
prior to the binding share exchange trigger "gross earnings" under section 186 of the
Tax Law?
Question 2:

Will Petitioner's transfer of the stock of Energetix and RGS to Holding Company
prior to the binding share exchange trigger "gross income" under section 186-a of the
Tax Law?

Question 3:

Will Petitioner's transfer of the stock of Energetix and RGS to Holding Company and
the subsequent binding share exchange result in a "dividend" subject to the tax on
excess dividends ("Excess Dividends Tax") pursuant to section 186 of the Tax Law?

Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner is a regulated public utility incorporated in New York State that supplies utility
services in western New York. Its principal offices are located in Rochester, New York and its
common stock is publicly traded. Moreover, Petitioner is subject to taxes under sections 186 and
186-a of the Tax Law.
Under a proposed reorganization that is expected to take effect in the spring of 1999,
Petitioner will become a subsidiary of Holding Company ("Holding Company"). Pursuant to the
proposed reorganization, the following steps will occur:
1. Petitioner will create Holding Company as a first tier, wholly owned subsidiary.

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2. Before the binding share exchange described below, Petitioner will contribute the
   stock of certain unregulated subsidiaries to Holding Company so that after the
   binding share exchange such companies will be first tier subsidiaries of Holding
   Company.
3. In accordance with a plan of share exchange adopted pursuant to section 913 of the
   Business Corporation Law and subject to shareholder approval, each share of
   Petitioner's common stock immediately prior to the effective time of the
   reorganization will be exchanged for one share of Holding Company common stock.
4. As a result of the binding share exchange, Holding Company will own 100
   percent of Petitioner's common stock. The current preferred shareholders of
   Petitioner will remain preferred shareholders of Petitioner after the exchange.
   After the binding share exchange, Holding Company will become a publicly traded company and
   will be subject to taxation under Article 9-A of the Tax Law. Petitioner states that before and after
   the reorganization, Petitioner will be taxed under Article 9 of the Tax Law.
   Petitioner is engaging in the proposed reorganization in response to the Public Service
   Commission's ("PSC") direction to restructure the electric utility industry in New York State. In
   1994, the PSC commenced hearings to explore restructuring the electric utility industry to encourage
   competition and permit customers to choose their electricity providers. In PSC Opinion and Order
   Regarding Competitive Opportunities for Electric Service, Opinion No. 96-12, issued May 20, 1996,
   the PSC enunciated its desire to bring New York consumers the innovations and efficiencies of
   competitive markets, together with economic development, lower electric prices and greater
   consumer choice, while, at the same time, maintaining the safety and reliability of electric service.
   In furtherance of this stated goal, the PSC required Petitioner, along with other utilities, to file plans
   to create a competitive electricity market in New York State1.
   In response to Opinion No. 96-12, Petitioner submitted its plan on October 1, 1996, and the PSC
   instituted Case 96-E-0898 for the purpose of examining Petitioner's submission. The Initial
   Settlement Agreement was filed on April 8, 1997, and after revisions, an Amended and Restated
   1

Additionally, the Federal Energy Regulatory Commission ("FERC") issued Order No.
636, in 1992, and Order No. 888, in 1996. Among other things, Order 636 mandates the
unbundling of interstate pipeline sales service and establishes certain open access transportation
requirements. Order 888 requires public utilities controlling transmission facilities to open the
wholesale electricity market to increased competition by filing non-discriminatory open access
transmission tariffs. In early 1997, Petitioner and the other New York State electric utilities
made such a filing with the FERC.

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Settlement Agreement ("Revised Settlement") was reached on October 23, 1997 by Petitioner, PSC
staff, Multiple Intervenors, Joint Supporters, and the National Association of Energy Service
Companies. The Revised Settlement was revised by the PSC's Opinion and Order Adopting Terms
of Settlement Subject to Conditions and Changes, Opinion No. 98-1 ("Order"), issued and effective
January 14, 1998. The Order requires Petitioner to functionally separate its three regulated
operations: distribution, generation and retailing. Additionally, any unregulated operations must
be structurally separate from the regulated utility functions.
The holding company structure is responsive to the PSC's directive in the Order to promote
competition in the utility industry, while at the same time protecting Petitioner's customers and the
regulated businesses from the risks inherent in operating competitive businesses. This is
accomplished by establishing Petitioner, which will operate the regulated businesses, as a direct
subsidiary of Holding Company. Current and future unregulated businesses will operate in
companies that are subsidiaries of Holding Company. This corporate structure will protect the
regulated businesses from the risks inherent in the Holding Company's competitive businesses.
The two unregulated subsidiaries that Petitioner will contribute to Holding Company prior
to the binding share exchange are Energetix Inc. ("Energetix") and RGS Development Corporation
("RGS"). Energetix is an unregulated subsidiary that will bring energy products and services to the
market place both within and outside Petitioner's regulated franchise territory. Energetix intends to
market electricity, natural gas, oil and propane fuel energy services in an area extending in a 150­
mile radius around Rochester. In furtherance of this goal, Energetix recently acquired Griffith Oil
Co., Inc. ("Griffith"), the second largest oil and propane distribution company in New York State.
In addition to its current products, Griffith will sell electricity, natural gas and other services offered
by Energetix to its existing customers. During the second quarter of 1998, Petitioner formed a new
unregulated subsidiary, RGS. RGS was formed to pursue unregulated business opportunities in the
energy marketplace. It is expected that Petitioner's basis in Energetix and RGS will equal or exceed
the fair market value of Energetix and RGS on the date of transfer.
Discussion
Section 186 of the Tax Law imposes a franchise tax upon every corporation, joint-stock
company or association formed for or principally engaged in the business of supplying gas, when
delivered through mains or pipes, or electricity, "for the privilege of exercising its corporate
franchise or carrying on its business in such corporate or organized capacity in this state". The tax
is three-quarters of one percent on the taxpayer's gross earnings from all sources within New York
State, and four and one-half percent on the amount of dividends paid during each year ending on the
thirty-first day of December in excess of four percent on the actual amount of paid-in capital
employed in New York State by the taxpayer.

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When section 186 of the Tax Law was enacted in 1896, it provided for a franchise tax
measured by "gross earnings from all sources within this state". In 1907, the Legislature amended
section 186 by providing a statutory definition of gross earnings. Gross earnings is defined as "all
receipts from the employment of capital without any deduction."
The definition of gross earnings was added to address a 1906 New York State Appellate
Division decision holding that in order to arrive at taxable "gross earnings", the cost of raw materials
used in producing the utility service was to be deducted from the company’s gross receipts. (See
People ex rel Brooklyn Union Gas Co. v Morgan, 114 App Div 266, affd 195 NY 616).
In 1969, the New York State Court of Appeals stated that "the 1907 amendment [of section
186] did not contemplate a substitution of 'capital' or 'gross receipts' for 'gross earnings' as the basis
for taxation. It merely sought to include that portion of capital which the Brooklyn Union Gas Co.
case [supra] required to be deducted from 'gross earnings' to arrive at the proper basis. This is only
that portion of 'gross earnings' which represents the 'employment of capital' to manufacture,
distribute and sell various public utility services." (Matter of Consolidated Edison Co. of NY v State
Tax Commission, 24 NY2d 114, 119). In the Con Ed case, the court determined that the proceeds
received by the company for property damage and insurance claims and from the sale of capital
assets no longer employed in its business, consisting of real property, scrap and used machinery, are
amounts realized from the destruction or confiscation of capital, not from the employment of capital.
In People ex rel Adams Electric Light Co v Graves, 272 NY 77,79, the Court of Appeals
stated that under the franchise tax imposed by section 186 of the Tax Law "[a] dividend on corporate
stock implies a division or distribution of corporate profits." In that case, the Court held that the
transfer of a portion of earned surplus to its non-par capital stock account, pursuant to a resolution
of its board of directors, was not a distribution of dividends for tax purposes. Neither money nor
property nor stock dividend went into the hands of stockholders. No stockholder acquired a right
to receive any equivalent of the amount transferred unless further corporate action was taken.
Petitioner is one of several utilities in New York State being compelled by the PSC to
reorganize their corporate structure and sell off some of their business to unrelated third parties
pursuant to the PSC's Competitive Opportunities Proceeding and the PSC's policy objectives set
forth in PSC Opinion No. 96-12. With respect to such mandated restructuring and divestiture, the
Commissioner of Taxation and Finance has issued an advisory opinion to Central Hudson Gas &
Electric Corporation, Adv Op Comm T&F, July 29, 1998, TSB-A-98(12)C. (See also, Long Island
Lighting Company, Adv Op Comm T&F, February 27, 1998, TSB-A-98(3)C ("LILCO") and New
York State Electric & Gas Corporation, Adv Op Comm T&F, July 29, 1998, TSB-A-98(11)C.) The
Central Hudson, supra, advisory opinion, reached several conclusions, including the following:

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1. The Existing Subsidiaries Spin-Off or any Genco Spin-Off is part of a
   series of transactions being entered into by Petitioner as mandated by the PSC
   pursuant to the Competitive Opportunities Proceeding and the PSC's policy
   objectives set forth in the Order (Opinion No. 96-12), and implemented under the
   restructuring plan described in the Restated Settlement Agreement dated January 2,
   1998 and modified February 26, 1998. Directly after the Share Exchange, Petitioner
   will distribute to Holdco all of the common stock of wholly-owned subsidiaries.
   Like Con Ed, supra, and LILCO, supra, Petitioner does not employ its capital within
   the meaning of section 186 of the Tax Law for the purpose of restructuring its
   organization, therefore, these transactions will not generate any "gross earnings" for
   Petitioner.
   With respect to the excise tax imposed under section 186-a of the Tax Law,
   Petitioner will realize "gross income" to the extent that a profit is generated. The
   profit, if any, would equal the amount that the fair market value of the common stock
   of each of the subsidiaries exceeds Petitioner's book value of the common stock.
2. Petitioner's distribution to Holdco, directly after the Share Exchange, of all
   of the common stock of the corporations included in the Existing Subsidiaries
   Spin-Off and any Genco Spin-Off, is part of the series of transactions being entered
   into by Petitioner as mandated by the PSC pursuant to the PSC's Opinion No. 96-12,
   and implemented under Petitioner's restructuring plan whereby Petitioner is
   reorganized into the holding company structure. It does not represent a distribution
   of the profits of Petitioner. Accordingly, these restructuring distributions are not
   treated as dividends subject to the Excess Dividends Tax under section 186 of the
   Tax Law. The opinion held further that the answer would not change if Petitioner
   invests up to $100 million of equity in the Existing Subsidiaries prior to the Share
   Exchange and the Existing Subsidiaries Spin-Off.
   Section 186-a of the Tax Law imposes a tax on the furnishing of utility services that is equal
   to three and one-half percent of the gross income of a utility that is subject to the supervision of the
   PSC or the gross operating income of every other utility doing business in New York State. For
   purposes of section 186-a, a "utility" includes a person subject to the supervision of the PSC and
   every person (whether or not such person is subject to such supervision) who sells or furnishes gas
   or electricity, by means of mains, pipes, or wires, regardless of whether such activities are the main
   business of such person or are only incidental thereto.
   Gross income, as defined in section 186-a.2(c) of the Tax Law, consists of the following
   elements:

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1. receipts from any sale made or service rendered for ultimate consumption
   or use by the purchaser in New York State;
2. profits from the sale of securities;
3. profits from the sale of real property;
4. profits from the sale of personal property (other than inventory);
5. receipts from interest, dividends, and royalties, derived from sources
   within New York State; and
6. profits from any transaction (except sales for resale and rentals) within
   New York State whatsoever.
   In this case, Petitioner's transfer of the stock of Energetix and RGS to Holding Company
   prior to the binding share exchange is part of the series of transactions being entered into by
   Petitioner as mandated by the PSC pursuant to the Competitive Opportunities Proceeding and the
   PSC's policy objectives set forth in the PSC's Opinion No. 96-12, and implemented under the
   restructuring plan described in the Initial Settlement Agreement filed April 8, 1997, as amended and
   restated in the Revised Settlement dated October 23, 1997, as revised by the PSC's Order, Opinion
   No. 98-1 (Case 96-E-0898) issued and effective January 14, 1998, whereby Petitioner is reorganized
   into the holding company structure and divests itself of its unregulated operations to separate those
   operations from its regulated utility functions.
   With respect to Question 1, like Con Ed, supra, and Central Hudson, supra, Petitioner does
   not employ its capital within the meaning of section 186 of the Tax Law for the purpose of being
   forced to restructure its organization. Accordingly, the transfer of the stock of Energetix and RGS
   to Holding Company without receiving any consideration in exchange for such stock, pursuant to
   the Order, would not result in "receipts from the employment of capital" and there will not be any
   gross earnings from such transaction under section 186 of the Tax Law.
   With respect to Question 2, Petitioner would realize "gross income" under section 186-a of
   the Tax Law, to the extent that a profit is realized from the transfer of the stock of Energetix and
   RGS to Holding Company pursuant to the Order. The profit, if any, would equal the amount that
   the fair market value of the stock of each subsidiary, Energetix and RGS, exceeds Petitioner's book
   value of the stock. Petitioner states that it is expected that its basis in these subsidiaries will equal
   or exceed the fair market value of the subsidiaries on the date of transfer. If this is indeed the case,
   then Petitioner will not realize any "gross income" under section 186-a of the Tax Law.

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With respect to Question 3, Petitioner's transfer of the stock of Energetix and RGS to
Holding Company prior to the binding share exchange, pursuant to the Order, does not represent a
distribution of the profits of Petitioner as contemplated in Adams Electric, supra. Accordingly, such
transaction would not be treated as a dividend subject to the Excess Dividends Tax under section 186
of the Tax Law.

DATED: January 27, 1999

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

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