Market-priced solar service systems are not public utility property

Plain-English summary

A company proposed owning and maintaining solar systems on customers'
premises under long-term service agreements. Customers would receive a share
of the electricity in exchange for monthly fees negotiated at arm's length
using market factors, not cost-of-service or rate-of-return ratemaking. Two
states had approved the solar services program, while a third state's program
was not regulated by any state or federal body. The IRS explained that public
utility property requires regulated rates determined on a rate-of-return
basis. Because the customer fees are market-based rather than rate-of-return
prices, the systems are not public utility property under IRC § 168(i)(10) and
former § 46(f)(5), including in the states where the program itself was
approved.

Ruling snapshot

• Question: Are customer-site solar systems public utility property when
  service prices are negotiated at market rates rather than set through
  rate-of-return regulation?
• Outcome: Approved, the systems are not public utility property
• Key authorities: IRC §§ 168(f)(2), 168(i)(10), and 50(d)(2); former IRC
  §§ 46(f)(5) and 167(l)(3)(A); Treas. Reg. §§ 1.46-3(g)(2)(iii) and
  1.167(l)-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202046007 Third Party Communication: None
Release Date: 11/13/2020 Date of Communication: Not Applicable
Index Number: 168.24-00
Person To Contact:
--------------------------------- ------------------, ID No. -----------------
--------------------------- Telephone Number:
---------------------------------- --------------------
------------------------------- Refer Reply To:
--------------------------- CC:PSI:B06
PLR-106281-20
Re: ---------------------------------- Date:
August 13, 2020

LEGEND

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

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

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

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

State C = --------------------

State D = ---------

Commission 1 = -----------------------------------------------

Commission 2 = ------------------------------------------------------

Commission 3 = ----------------------------------------------

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

Year = -------

a = -----

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

  This letter responds to your request dated February 12, 2020, for a ruling

regarding the application of § 168(i)(10) and former § 46(f)(5) of the Internal Revenue
PLR-106281-20 2

Code to the facts described below. The relevant facts as represented in your
submission are set forth below.

FACTS

   Taxpayer is a publicly-traded holding company incorporated in State A. It is the

parent of a group of affiliated companies that files a consolidated federal income tax
return on a calendar year basis using an accrual method of accounting. The Company,
a State A limited liability company, is a wholly-owned indirect subsidiary of Taxpayer.
The Company is disregarded as an entity separate from Taxpayer for federal income
tax purposes. The Company’s offices are located in State B.

    The Company was created to serve customers by providing energy services from

renewable energy sources through long-term contractual agreements with customers.
The Company has received certificates from Commission 1 and Commission 2 to lease
electric generating facilities in State B and State C. The Company has solar energy
leasing businesses in State B, State C, and State D (Solar Services Program). The
Company’s Solar Services Program in State D is not subject to the regulatory
jurisdiction of Commission 3, or to rate regulation by any other state or federal
regulatory body. The Company began marketing its solar energy services in State D in
the first quarter of Year.

    Under the Company’s Solar Services Program, the Company will enter into a

Solar Energy Service Agreement (Agreement) with a participating customer (Customer)
for the provision of services (Solar Energy Services) with respect to a solar photovoltaic
generation system (System) to be constructed and installed on the Customer’s
premises. The Company will own, operate, and maintain the System during the term of
the Agreement. Under the Agreement, the Customer is entitled to a percent of the
electrical energy generated by the System in exchange for a monthly fee, which could
include a fixed percentage price escalator.

   Participation in the Company’s Solar Services Program is voluntary. None of the

costs of the solar facilities installed under the Company’s Solar Services Program will
be included in a regulated rate base for the purpose of determining the price for Solar
Energy Services. Instead, the Company will establish a market-based price for Solar
Energy Services, to be determined with each Customer through arm’s-length
negotiation, based on criteria that includes, but is not limited to, an evaluation of the
Customer’s creditworthiness. Rates charged to Customers under the Company’s Solar
Services Program will be based on market-based prices for the particular System that
each Customer selects to match its individual needs. Individual rates under the
Agreement will not be set by, or subject to the approval of, any governmental or other
regulatory body.
PLR-106281-20 3

RULING REQUESTED

    The Taxpayer requests a ruling that the System will not be public utility property

within the meaning of § 168(i)(10) and former § 46(f)(5) because the contract price
under the Agreement and the Company’s Solar Services Program is not a cost-of-
service based, rate-of-return price for the furnishing of electrical energy, and because
the Company’s Solar Services Program in State D is not subject to the regulatory
jurisdiction of Commission 3 or any other state or federal regulatory body.

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
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, even 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 the same. 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 or not
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).
PLR-106281-20 4

   The regulations under former § 46 (of continuing applicability by virtue of

§ 50(d)(2)) contain an expanded definition of regulated rates in § 1.46-3(g)(2)(iii). 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 the 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.

   The System will meet the first requirement as it will be used predominantly in the
   trade or business of the furnishing or sale of electrical energy.

   The System will meet the second requirement with respect to the Company’s
   Solar Services Program in State B and State C, as the Solar Services Program was
   approved by Commission 1 and Commission 2.

   The System will not meet the second requirement with respect to the Company’s
   Solar Services Program in State D, as the Company’s Solar Services Program in State
   PLR-106281-20 5

D is not subject to the regulatory jurisdiction of Commission 3, or to rate regulation by
any other state or federal regulatory body.

    The System will not meet the third requirement because the monthly fee under

the Agreement will not be determined on a rate-of-return basis. Instead, the Company
will establish a market-based price for Solar Energy Services, determined through
arm’s-length negotiations with Customers. Individual rates under the Agreement will not
be set by, or subject to the approval of, any governmental or other regulatory body.

 Accordingly, we conclude that the System is not public utility property within the

meaning of § 168(i)(10) and former § 46(f)(5).

   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 System
generating electricity for federal income tax purposes.

    This letter 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 letter 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 ruling is being sent to your authorized
representative. We are also sending a copy of this letter ruling to the Director.

                                        Sincerely,



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

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