IRS says two renewable-energy facilities are not public utility property

Plain-English summary

A regulated electric utility planned to develop one solar and battery facility and acquire another under a state renewable-energy program. State law permanently excluded both facilities' capital investment and operating costs from the utility's rate base and revenue requirement. The electricity prices would instead be based on competitive market prices that the state commission found just and reasonable. The IRS explained that public utility property under the depreciation and investment-credit normalization rules requires rates set on a rate-of-return basis. Because these facilities would not recover costs or capital through rate-of-return regulation, the IRS ruled that neither facility would be public utility property under former IRC § 46(f) and IRC § 168(i)(10).

Ruling snapshot

• Question: Were two renewable-energy facilities public utility property when their costs were excluded from rate base and their electricity prices were market-based?
• Outcome: approved (neither facility was public utility property under the cited normalization rules)
• Key authorities: IRC §§ 46(f), 50(d)(2), 167(l), 168(f)(2), 168(i)(10); Treas. Reg. §§ 1.46-3(g)(2)(iii), 1.167(l)-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202032002 Third Party Communication:
Release Date: 8/7/2020 Date of Communication: Not Applicable
Index Number: 168.24-00
Person To Contact:
------------------- --------------- ID No. ------------
--------------------------------- Telephone Number:
-------------------------------------- --------------------
------------------------- Refer Reply To:
CC:PSI:B06
PLR-122199-19
Date:
March 20, 2020
Re: ---------------------------------

LEGEND:

Parent = ----------------------------------------------------------

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

Subsidiary 1 = ----------------------------------------------

Subsidiary 2 = ----------------------------------------------------------
------------------

Company = ---------------------------------------------------

Commission A = ---------------------------------------------------

Commission B = -----------------------------------------------------

State A = ----------

State B = -------------

State C = ------

a = ------

b = -----

c = -----

d = -----

e = -----

PLR-122199-19 2

Bill = -------------------------------------

Facility A = -------------------------------

Facility B = ---------------------------------------

Location A = -----------------------------------

Location B = ------------------------------

Date 1 = ------------------

Date 2 = -----------------

Date 3 = ---------------------

Date 4 = --------------------------

Date 5 = -----------------

Year = -------

Department = ---------------------------------------

Director = ---------------------------------------

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

This letter responds to your request, dated September 18, 2019, for a ruling regarding
certain federal income tax consequences under § 168(i)(10) and former § 46(f) of the
Internal Revenue Code of the proposed transactions described below. The relevant
facts as represented in your submission are set forth below.

FACTS

Taxpayer, a State A corporation, is a public utility serving retail electric customers in
State A. Taxpayer is a wholly-owned subsidiary of Subsidiary 1, a State A energy
holding company. Subsidiary 1 is wholly-owned by Company, a State B limited liability
company that is disregarded for federal income tax purposes and wholly-owned by
Subsidiary 2, a State C corporation. Subsidiary 2 is a percent owned by Parent. Parent
and its affiliated group of corporations, including Taxpayer, Subsidiary 1, and Subsidiary
2, file a consolidated federal income tax return on a calendar year basis using the
accrual method of accounting.

PLR-122199-19 3

Taxpayer is subject to regulation by Commission A and Commission B (Commissions)
for ratemaking purposes. The Commissions generally establish Taxpayer’s rates based
on the costs to provide regulated electric service, including a return on investment.
Taxpayer’s rates include two basic rate elements. The first, is a base tariff general rate
determined on a cost-of-service basis. The base tariff general rate revenue requirement
includes, among other costs, a return on the value of property dedicated to servicing the
public. The second, is a base tariff energy rate that reflects the actual cost of
purchased fuel, purchased power, and related expenses.

State A law requires Taxpayer to procure renewable energy to meet State A’s
renewable energy portfolio standard. Taxpayer has achieved this renewable energy
portfolio standard through both Taxpayer-owned rate-based facilities and power
purchase agreements (PPAs) secured using a competitive solicitation process. With
respect to PPAs, Taxpayer issues requests for renewable energy proposals and
presents the bids to Commission A for approval as part of an integrated resource plan
filing. Commission A determines if the price terms of the PPA are “just and reasonable.”
As part of the consideration for approval, Commission A considers which projects offer
the best value to the customer that can be delivered as scheduled and compares the
prices to other bids. Commission A does not compare the costs under a PPA to the
cost-of-service based revenue requirement of a renewable energy facility (REF),
including the facility producing the electricity sold under the PPA, to determine if the
proposed contract is “just and reasonable.”

On Date 1, the Governor of State A signed into law Bill. In addition to increasing State
A’s renewable energy portfolio standard, Bill created a new program that allows
Taxpayer to meet this standard by owning renewable energy facilities without general
rate approval for such ownership from Commission A.

With respect to self-developed projects, Section 6 of Bill has the following key
provisions: 1) Commission A may establish a “just and reasonable” price for the energy
produced by a REF owned by a utility by reference to a competitive market price,
without regard or reference to the principles of cost of service or rate of return price
setting; and 2) any capital investment associated with the REF must be excluded from
the rate base of the utility and expenses associated with such facility must be excluded
from the revenue requirement.

With respect to property that is acquired (either existing or being developed), Section 7
of Bill provides the following key provisions: 1) a utility may, without additional approval
of Commission A, acquire an existing REF or a REF that is being developed if
Commission A has approved the purchase of electricity generated by the REF pursuant
to a PPA (under the competitive market-based process described above); and 2) a
utility must submit notice to Commission A that (a) the utility will not include the REF in
its rate base or expenses associated with the facility in its revenue requirement, (b) the
utility will charge the “just and reasonable” contract price for electricity originally
approved by Commission A with respect to the PPA approved by Commission A, and

PLR-122199-19 4

(c) the utility acknowledges that following the conclusion of the term of the agreement,
the utility must not include any capital investment associated with the REF in the utility’s
rate base or expenses associated with the REF in the utility’s revenue requirement.

Pursuant to the requirements of Bill, Taxpayer intends to (1) self-develop Facility A
(Section 6 of Bill) and (2) acquire Facility B (Section 7 of Bill). Taxpayer represents that
Facility A and Facility B will satisfy the requirements of Bill, including that Facility A’s
and Facility B’s capital investment and costs associated with the facilities were never
included in (and will be permanently excluded from) Taxpayer’s rate base and revenue
requirements.

Taxpayer is self-developing Facility A, which will be located in Location A. Taxpayer is
finalizing the construction process of Facility A under the terms of an engineering,
procurement, and construction contract that is expected to be executed by Date 2.
Facility A is a b-megawatt solar facility with c-megawatts of battery storage. Taxpayer
finalized the Right of Way Grants from Department on Date 3. Taxpayer expects to
place the property in service at the end of Year. Facility A will produce electricity that
Taxpayer will sell to its retail customers in State A.

Facility B involves the development of a d-megawatt solar facility with approximately e-
megawatts of battery storage in Location B. Facility B is expected to begin commercial
operation by Date 4. An unrelated third party will develop the facility and transfer it to
Taxpayer upon completion and prior to mechanical operation. A definitive Build
Transfer Agreement is expected to be signed on Date 5. Facility B will produce
electricity that Taxpayer will sell to its retail customers in State A.

RULINGS REQUESTED

Taxpayer requested the following rulings:

(1) Facility A, as a REF that satisfies the requirements of Section 6 of Bill, will not be
public utility property within the meaning of former § 46(f) (of continuing
applicability by virtue of § 50(d)(2), § 168(i)(10) and the regulations promulgated
thereunder.

(2) Facility B, as a REF that satisfies the requirements of Section 7 of Bill, will not be
public utility property within the meaning of former § 46(f) (of continuing
applicability by virtue § 50(d)(2), § 168(i)(10) and the regulations promulgated
thereunder.

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.

PLR-122199-19 5

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
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

PLR-122199-19 6

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

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

Taxpayer will predominantly use Facility A and Facility B in the trade or business of the
furnishing or sale of electric energy. Therefore, Facility A and Facility B will meet the
first requirement. In addition, Taxpayer is a regulated public utility company subject to
the jurisdiction of federal and state law, including the ratemaking jurisdiction of
Commission A. Therefore, Facility A and Facility B will also meet the second
requirement.

However, as described above, the rates Taxpayer charges for electricity to be produced
by Facility A and Facility B will be the rates determined to be “just and reasonable” by
reference to competitive market prices through the program established under Bill.
These rates will be the only source of compensation to Taxpayer for electricity produced
by Facility A and Facility B. The process outlined in Bill by which Taxpayer can charge
rates to State A customers does not include recovery of Taxpayer’s costs on a cost-of-
service basis, and all costs, including any cost of capital and capital investments, of
Facility A and Facility B will be permanently excluded from Taxpayer’s rate base and
revenue requirements. Thus, the program provided under Bill cannot be characterized
as rate-of-return price setting. Therefore, Facility A and Facility B will not meet the third
requirement.

Accordingly, we conclude that:

(1) Facility A, as a REF that Taxpayer represents satisfies the requirements of
Section 6 of Bill, will not be public utility property within the meaning of former

PLR-122199-19 7

     § 46(f) (of continuing applicability by virtue of § 50(d)(2), § 168(i)(10) and the
     regulations promulgated thereunder.

  (2) Facility B, as a REF that Taxpayer represents satisfies the requirements of
      Section 7 of Bill, will not be public utility property within the meaning of former
      § 46(f) (of continuing applicability by virtue § 50(d)(2), § 168(i)(10) and the
      regulations promulgated thereunder.

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). In addition, no opinion is
expressed concerning whether Taxpayer is the owner of the facilities generating
electricity for federal income tax purposes.

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 by 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,


                                      Jennifer A. Records
                                      Senior Technician Reviewer, Branch 6
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

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