Generator-funded transmission upgrades qualify as capital contributions

Plain-English summary

A regulated electric utility agreed to construct transmission upgrades funded by wind-farm operators whose generation was sometimes curtailed by congestion. The utility would own and operate the upgrades, would not include their cost in its regulated rate base, and projected that no more than 5 percent of total power flows over them would flow to the generators. The generators were not utility customers and would amortize their payments over 20 years. The IRS concluded that the deemed transfer of the intertie and the construction payments met Notice 2016-36's safe harbor. The amounts therefore were not contributions in aid of construction under section 118(b) and were excluded from the utility's gross income as nonshareholder contributions to capital under section 118(a).

Ruling snapshot

• Question: Are generator-funded transmission upgrades excluded from a utility's income as nonshareholder capital contributions rather than taxable contributions in aid of construction?
• Outcome: approved
• Key authorities: IRC §§ 61, 118(a), and 118(b); Treas. Reg. §§ 1.61-1 and 1.118-1; Notice 2016-36

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201803008                                               Third Party Communication: None
Release Date: 1/19/2018                                         Date of Communication: Not Applicable
Index Number: 118.01-04
                                                                Person To Contact:
---------------------------                                     ----------------, ID No. ------------------
--------------------------------------------------------        Telephone Number:
-----------------------------------                             ----------------------
--------------------------------                                Refer Reply To:
----------------------------                                    CC:PSI:B05
                                                                PLR-130657-14
In Re:                                                          Date:
         ------------------------.                              October 18, 2017




Legend

Taxpayer                   =         ------------------------------------
--------------------------------------------------------------

Company 1                  =         -----------------------------------------------

Corp 1                     =         -----------------------------------
--------------------------------------------------------------

Administrator 1            =         ------------------------------------------------------------------

Administrator 2            =         ------------------------------------

Agreement                  =         -------------------------------------------------------------
----------------------------------------------------------------------

Dear ----------------:

      This letter responds to a request for a ruling dated July 31, 2014, and
subsequent correspondence submitted on behalf of Taxpayer by your authorized
representatives. Taxpayer requested a ruling that certain payments Taxpayer received
are contributions to the capital of Taxpayer under § 118(a) of the Internal Revenue
Code. The relevant facts as represented in your submission are set forth below.

                                                      FACTS

       Taxpayer, an indirect, wholly-owned subsidiary of Corp 1, is incorporated in the
State of -----------. Taxpayer is included in the consolidated federal income tax return of
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Corp 1. Taxpayer employs the accrual method of accounting and reports on a calendar
year basis. Taxpayer is a regulated public utility that generates, transmits, distributes
and sells electricity to customers. Taxpayer is subject to regulation by the ------------------
--------------------------------- and the Federal Energy Regulatory Commission (“FERC”).

       Taxpayer is a member of Administrator 1. Administrator 1 is a FERC-approved
regional transmission operator (“RTO”), which oversees the operation of the bulk power
transmission system for a substantial portion of the -----------------------------------.
Administrator 1 maintains operational reliability of the transmission system, plans for
transmission and generation resources, manages the market for electric energy and
related services, and administers the FERC tariffs for transmission service.

         This ruling request involves certain payments to Taxpayer made by ---------
entities that own and operate wind generation facilities. These entities are -----------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------- (collectively, “Generators”). Each
Generator operates a wind farm (collectively, “Facilities”) located in -----------. Each
Facility is interconnected with the transmission system owned by Company 1 and
controlled by Administrator 2. Company 1 is a regulated electric utility which generates,
distributes, transmits and sells electricity in parts of ------------------------------.
Administrator 2 is a FERC-approved RTO that oversees the operation of the bulk power
transmission system in all or parts of ---- states and --------------------------------, including
the part of ----------- where the Generators are located.

         The power produced by Generators is initially transported over transmission lines
that are not owned by Taxpayer and not controlled by Administrator 1. Taxpayer
received no payments from Generators at the time they entered into Interconnection
Service Agreements (“ISAs”) with Administrator 2 and Company 1 in -------. The ISAs
required Generators to reimburse Company 1 for the cost of the interconnection
facilities. Generators are not customers of Company 1. The electricity they produce is
sold at the busbar of each of Facilities. The terms of the ISAs with Company 1 are all
long term.

       Taxpayer’s transmission system is interconnected with the transmission system
owned by Company 1 and controlled by Administrator 2. As a result of the configuration
of these two interconnected transmission systems, the volume of electricity being
carried on Taxpayer’s system can congest Company 1’s system. Administrator 1 and
Administrator 2 have an operating agreement that allows one to notify the other of the
need to curtail one or more generators when congestion occurs.

       Congestion on Taxpayer’s transmission system at certain points occasionally
impacts Generators directly. When this congestion occurs, Generators are curtailed. At
the request of Generators, Administrator 1 determined that if Taxpayer constructs
PLR-130657-14                                 3

certain upgrades to its transmission system, it would alleviate congestion such that their
generation activities within the Administrator 2 market would be curtailed less
frequently. Specifically, Taxpayer needs to upgrade a substation and reconductor -------
segments of a transmission line circuit (collectively, “Upgrades”).

       On --------------------------, Taxpayer, Administrator 1, and Generators entered into
Agreement, pursuant to which Taxpayer will construct Upgrades. Agreement provides
that Generators are obligated to pay Taxpayer costs associated with seeking all
necessary approvals and testing Upgrades, including tax gross-up amounts. Taxpayer
will own and operate Upgrades. Generators are not and will not become customers of
Taxpayer. Taxpayer will not include the cost of Upgrades in its regulated rate base.
Generators will amortize their payments to Taxpayer over a twenty-year period.
Additionally, no more than 5% of the projected total power flows over Upgrades will flow
to Generators.

                                  RULING REQUESTED

       Taxpayer requests a ruling that the contribution of the intertie, and all sums paid
for construction of the intertie, are not a contribution in aid of construction (CIAC) under
§ 118(b), and are excludable from Taxpayer’s gross income as a non-shareholder
contribution to capital under § 118(a).

                                  LAW AND ANALYSIS

      Section 61 and § 1.61-1 of the Income Tax Regulations provide that gross
income means all income from whatever source derived, unless excluded by law.

       Section 118(a) provides that, in the case of a corporation, gross income does not
include any contribution to the capital of the taxpayer.

      Section 118(b) provides that the term “contribution to the capital of the taxpayer”
does not include any contribution in aid of construction or any other contribution as a
customer or potential customer.

       Section 1.118-1 of the Income Tax Regulations provides that in the case of a
corporation, § 118 provides an exclusion from gross income with respect to any
contribution of money or property to the capital of the taxpayer. Thus, if a corporation
requires additional funds for conducting its business and obtains such funds through
voluntary pro rata payments by its shareholders, the amounts so received being
credited to its surplus account or to a special account, such amounts do not constitute
income, although there is no increase in the outstanding shares of stock of the
corporation. In such a case the payments are in the nature of assessments upon, and
represent an additional price paid for, the shares of stock held by the individual
shareholders, and will be treated as an addition to and as a part of the operating capital
PLR-130657-14                                   4

of the company. Section 118 also applies to contributions to capital made by persons
other than shareholders. For example, the exclusion applies to the value of land or
other property contributed to a corporation by a governmental unit or by a civic group for
the purpose of inducing the corporation to locate its business in a particular community,
or for the purpose of enabling the corporation to expand its operating facilities.

        Notice 2016-36, 2016-25 I.R.B. 1029, provides a safe harbor for transfers of
property from either an electricity generation or cogeneration facility or an energy
storage facility to a regulated public utility, used to facilitate the transmission of
electricity over the utility’s transmission system, to be treated as a contribution to the
capital of a corporation under § 118(a), and not a contribution in aid of construction
(CIAC) under § 118(b).

         The safe harbor provides that a contribution of an intertie, including a dual-use
intertie, by a generator to a utility will not be treated as gross income under § 118(a) or
a CIAC under § 118(b) if all of the following conditions are met. First, the generator may
not purchase electricity from the utility, unless the purchase satisfies the 5% test. The
5% test provides that if, in light of all information available to the utility at the time the
intertie is contributed, it is reasonably projected that, during the ten taxable years of the
utility beginning with the year in which the contributed intertie is placed in service, no
more than 5% of the projected total power flows over the intertie will flow to the
generator, the 5% test will be satisfied. This projection must be supported by
appropriate documentation. Total power flows mean power flows to or from the
generator over the intertie. Power flows to a generator include power flows to a related
party of the generator, if the transmission of power to the related party has been
facilitated by the contribution of the intertie. For purposes of the 5% test, power flows in
the taxable year in which the transferred property is placed in service may, at the option
of the utility, be ignored. Power purchases by the generator from parties other than the
utility are not taken into account.

        Second, in the case of electricity wheeled over the utility’s transmission system,
ownership of the wheeled electricity remains with the generator prior to its transmission
onto the grid. This ownership requirement is deemed to be satisfied if title to electricity
wheeled passes to the purchaser at the busbar on the generator's end of the intertie.
Third, the cost of the intertie is not included in the utility’s rate base. Fourth, the intertie
will be used for transmitting electricity. Finally, the cost of the intertie is capitalized by
the generator as an intangible asset and recovered using the straight-line method over
a useful life that is treated as 20 years. A utility may not claim depreciation (or
amortization) deductions with respect to the intertie. However, if the intertie is
subsequently transferred or deemed transferred to the utility, the utility may be allowed
to take depreciation deductions with respect to the intertie.

       Section VIII of Notice 2016-36 provides that the IRS will not issue private letter
rulings involving the safe harbor under Notice 2016-36. Further, section 6.09 of Rev.
PLR-130657-14                                  5

Proc. 2017-1, 2017-1 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. Section
3.01(24) of Rev. Proc. 2017-3 provides that the Service will not issue rulings or
determination letters concerning whether a transfer of an intertie, as defined in section
III. B. 2. of Notice 2016–36 meets all of the requirements under the safe harbor provided
by Notice 2016–36. In this case, Taxpayer requested the private letter ruling before the
project that led to publication of Notice 2016-36 was opened and before the addition of
this area to Rev. Proc. 2017-3. In the interest of sound tax administration and because
the circumstances of this particular case warrant the issuance of a private letter ruling,
we are issuing this private letter ruling.

       In the instant case, the transfer of the intertie is subject to the guidance set forth
in Notice 2016-36, and we conclude that the deemed contribution of the intertie by
Generators to Taxpayer meets the safe harbor requirements of Notice 2016-36.
Therefore, the deemed contribution of the intertie to Taxpayer, and all sums paid for
construction of the intertie are not a CIAC under § 118(b), and are excludable from
Taxpayer's gross income as a non-shareholder contribution to capital under § 118(a).

        A change in a utility’s treatment of a transfer of an intertie, including a change to
or from the safe harbor method of accounting provided in section III of Notice 2016-36,
is a change in method of accounting to which the provisions of §§ 446 and 481 and the
regulations thereunder apply. A utility that wants to change to the methods of
accounting described in this notice must use the automatic change procedures in Rev.
Proc. 2015-13, 2015-5 I.R.B. 419, or its successor. Taxpayer should follow the
instructions under section 15.16 of Rev. Proc. 2016-29, 2016-21 I.R.B. 880 with respect
to the transaction described in this letter ruling.

      Except as specifically set forth above, no opinion is expressed or implied
concerning the federal income tax consequences of the above described facts under
any other provision of the Code or regulations.

      This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

      This ruling is based upon information and representations submitted by the
taxpayer and accompanied by a penalty of perjury statement executed by an
appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.
PLR-130657-14                                  6

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.


                                       Sincerely,



                                       Nicole R. Cimino
                                       Chief, Branch 5
                                       Office of Associate Chief Counsel
                                       (Passthroughs and Special Industries)

Enclosure: 6110 copy