Market-rate solar partnerships avoid utility normalization rules

Plain-English summary

A regulated utility planned to acquire solar projects, place them in tax-equity partnerships, and have those partnerships sell electricity directly into wholesale markets. The partnerships would receive market-based rate authority and would not sell power to the utility under power purchase agreements. Although the utility expected its investment in the partnerships to enter its retail rate base, the partnerships' power prices would not be set on a cost-of-service or rate-of-return basis. The IRS ruled that the solar facilities were not public utility property in the partnerships' hands and were not subject to depreciation or investment-tax-credit normalization rules. It also ruled that the facilities were not treated as public utility property directly owned by either partner because the partners were ineligible to elect out of partnership treatment under Section 761.

Ruling snapshot

• Question: Were market-priced solar facilities held through tax-equity partnerships public utility property for normalization purposes?
• Outcome: Approved.
• Key authorities: IRC §§ 46(f), 50(d)(2), 167, 168, and 761; Treas. Reg. §§ 1.46-3, 1.167(l)-1, and 1.167(l)-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202130005 Third Party Communication: None
Release Date: 7/30/2021 Date of Communication: Not Applicable
Index Number: 168.24-00
Person To Contact:
---------------------- --------------- ID No. --------------
----------------------------- Telephone Number:
--------------------------------- --------------------
------------------------------------ Refer Reply To:
------------------------ CC:PSI:B06
PLR-118549-20
Date:
May 06, 2021

Re: -------------------------------------------------------

LEGEND:

Taxpayer = --------------------------------------------------
------------------------
Parent = ------------------------------------
----------------------
HoldCo = --------------------
Commission A = ------------------------------------------------------
Commission B = -----------------------------------------------------
Operator = ----------------------------------------------------------------
State = --------------
a = ------
b = --
c = ------
d = ---
Date 1 = ------------------
Date 2 = ------------------
Year A = -------
Year B = -------
Director = ------------------------------------------

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

This letter responds to your request, dated August 18, 2020, for a ruling regarding
certain federal income tax consequences under § 168(i)(10) and former § 46(f)(5) of the
Internal Revenue Code of the proposed transaction described below. The relevant facts
as represented in your submission are set forth below.

FACTS
PLR-118549-20 2

Parent and Taxpayer, both State corporations, file a consolidated federal income tax
return on a calendar year basis with their affiliates. Taxpayer is a public utility engaged
principally in the generation and distribution of electricity and the distribution and
transportation of natural gas to retail customers in select markets in State.

Taxpayer is subject to regulation by Commission A and Commission B with respect to
the terms and condition of its services, including the rates it may charge for such
services. In each of these regulatory jurisdictions, Taxpayer’s rates are generally
established on a cost-of-service, rate-of-return basis.

On Date 1, Parent announced Taxpayer’s plans to acquire and advance a megawatts of
solar in b mostly rural counties in State. On Date 2, Taxpayer filed with Commission A
an application for a certificate of authority to acquire, construct, own, and operate b
solar electric generation facilities (Facility or Facilities) and an application for approval of
affiliated interest agreements related to ownership and operation of such Facilities. The
Facilities are expected to be placed in service between Year A and Year B. Taxpayer
also expects that the Facilities will qualify for the investment tax credit.

As of the date of this ruling request, the assets related to each Facility were held in
single-purpose, limited liability project companies (Developer ProjectCos), wholly owned
by their respective developers. Taxpayer has executed purchase and sale agreements
with the developers to acquire c percent of the membership interest in Developer
ProjectCos. Thereafter, Taxpayer will dissolve the Developer ProjectCos and assume
the assets of Developer ProjectCos.

Taxpayer will then organize a single-member limited liability company named HoldCo.
HoldCo will be a disregarded entity for federal income tax purposes and will organize a
set of limited liability companies (Project HoldCos). Each Project HoldCo will organize
one or more single-member limited liability companies (ProjectCos) that will be
disregarded entities for federal income tax purposes and will ultimately each own one of
the Facilities.

HoldCo will enter into an agreement with one or more unrelated financial institutions
(Partner) to sell a membership in each Project HoldCo to Partner. Upon mechanical
completion, Taxpayer will sell the assets and liabilities of each Facility to the appropriate
ProjectCo, which will trigger a commitment by Partner to contribute capital to each
Project HoldCo. Each Project HoldCo will execute an LLC Agreement that will allocate
cash and property distributions; profits, losses, and tax credits; and other
rights/responsibilities between HoldCo and Partner. Each Project HoldCo will be
treated as a partnership for federal income tax purposes, and each ProjectCo owning a
Facility with be treated as a disregarded entity for federal income tax purposes and as
part of a Project HoldCo (Project HoldCo and ProjectCo will hereinafter be collectively
referred to as Partnership). Each Partnership will file for and is expected to receive
market-based rate authority from Commission B allowing it to make any sales of
electricity, capacity, and ancillary services at market-based rates, rather than cost-
PLR-118549-20 3

based rates with a regulated rate of return. From the date of commercial operation,
each Partnership will sell electricity produced by its Facility directly to the wholesale
electricity markets administered by Operator. Partnership will not sell power to
Taxpayer and there will not be a power purchase agreement between Partnership and
Taxpayer.

Taxpayer will acquire electricity from the wholesale electricity markets at market prices
as administered by Operator. The timing and volumes of purchased power will be
determined based on demand for power by Taxpayer’s customers in the normal course
of business operations and without regard to the timing and volumes of power sold by
Partnership.

As part of the proceedings with Commission A, Taxpayer is requesting that it be able to
include the unrecovered cost of its investment in Partnership in rate base and that it be
able to recover the cost of its investment in Partnership ratably over d years. Cash
distributions from the Partnership to Taxpayer will reduce cost of service recoverable
from customers.

RULINGS REQUESTED

Taxpayer requested the following ruling:

• The Facilities owned by each Partnership are not public utility property under
§ 168(i)(10) and former § 46(f)(5) and, thus, each Partnership is not subject to
the deferred tax normalization rules of § 168(i)(9) or the investment tax credit
normalization rules of former § 46(f).
• The Facilities are not treated as public utility property owned by Taxpayer or
Partner under § 168(i)(10) or § 1.167(l)-3(c) of the Income Tax Regulations.

LAW AND ANALYSIS

First Ruling

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.
PLR-118549-20 4

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
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.
PLR-118549-20 5

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.

Partnerships will predominantly use the Facilities in the trade or business of the
furnishing or sale of electric energy. Therefore, the Facilities will meet the first
requirement. In addition, each Partnership will be under the jurisdiction of Commission
B. Therefore, the Facilities will also meet the second requirement.

However, as described above, each Partnership will set the rates it charges Operator
for electricity to be produced by the Facilities under the market-based rate authority of
Commission B (not on a cost-of-service or rate-of-return basis). Accordingly, we
conclude that the Facilities owned by Partnerships will not to be public utility property
within the meaning of § 168(i)(10) and former § 46(f)(5).

Second Ruling

Section 1.167(l)-3(c) provides, in relevant part, that if property held by a partnership is
not public utility property in the hands of the partnership but would be public utility
property if an election was made under § 761 to be excluded from partnership
treatment, then section 167(l) shall be applied by treating the partners as directly
owning the property in proportion to their partnership interests. Therefore, § 1.167(l)-
3(c) first considers whether such property is public utility property at the partnership
level. If not, it then considers whether such property would be public utility property at
the partner level, but only if the partnership is of a type that the partners are eligible to
elect out of partnership treatment under § 761.

As discussed above with respect to the first ruling request, the Facilities are not
considered public utility property in the hands of the Partnerships. In addition, Taxpayer
represents that Taxpayer and Partner are ineligible under § 761 to elect out of
partnership treatment. The inability of Taxpayer and Partner to make such an election
removes the Facilities from § 1.167(l)-3(c) consideration in the hands of Partner and
Taxpayer. Accordingly, based solely on Taxpayer’s representations, we conclude that
PLR-118549-20 6

the Facilities are not treated as public utility property owned by Taxpayer or Partner
under § 168(i)(10) or § 1.167(l)-3(c).

Except as explicitly 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). Specifically, Taxpayer
has not requested a ruling regarding whether the Partnerships will be respected as
partnerships for federal income purposes nor provided partnership agreements for
Partnerships. Accordingly, nothing in this letter should be construed as providing a
ruling or other determination that the Partnerships will be respected as partnerships or
that any purported owner will be respected as a partner 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 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 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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