A utility's solar facilities sold at competitive market rates are not "public utility property," so the depreciation normalization rules do not apply

Plain-English summary

Regulated utilities that recover their costs through traditional "rate-of-return" ratemaking must use a slower "normalization" method of accounting for their depreciation on "public utility property"; property that falls outside that definition is not subject to those restrictions. Here two electric utilities planned to acquire two solar generating facilities to meet a state renewable-energy mandate. Under a special state law, the power from those facilities is priced by reference to competitive market rates, not on a cost-of-service, rate-of-return basis, and the facilities' capital costs are permanently excluded from the utilities' rate base. The utilities asked the IRS to confirm the facilities are not "public utility property." The IRS explained that property is public utility property only if its rates are set on a rate-of-return basis, and since these facilities' rates are set competitively rather than by rate-of-return regulation, they fail that test. The IRS ruled the two solar facilities are not public utility property under section 168(i)(10) or former section 46(f). Practically, this frees the utilities from the normalization limits on how they depreciate the facilities.

Ruling snapshot

• Question: Are two utility-owned solar facilities, whose output is priced at competitive market rates rather than on a rate-of-return basis, "public utility property"?
• Outcome: Approved (ruled the facilities are not public utility property under section 168(i)(10) or former section 46(f), as requested).
• Key authorities: IRC § 168(i)(10), (f)(2); former IRC § 46(f) (continued by IRC § 50(d)(2)); Treas. Reg. §§ 1.46-3(g), 1.167(l)-1.

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202208005                                              Third Party Communication: None
 Release Date: 2/25/2022                                        Date of Communication: Not Applicable
 Index Number: 168.24-00
                                                                Person To Contact:
 -------------------                                            ---------------, ID No. ------------
 -------------------------------                                Telephone Number:
 --------------------------------                               --------------------
 --------------------------------------                         Refer Reply To:
 -------------------------                                      CC:PSI:B06
 ---------------------------                                    PLR-112343-21
                                                                Date:
                                                                November 29, 2021
    Re: ---------------------------------




LEGEND:

P                                   =        ----------------------------------------------------------
S1                                  =        -----------------------------------------------------------
S2                                  =        ------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
S3                                  =        ----------------------------------------------
S4                                  =        -----------------------------------------------------------
                                             ------------------
Company                             =        ---------------------------------------------------
Commission A                        =        --------------------------------------------------
Commission B                        =        -----------------------------------------------------
State A                             =        ----------
State B                             =        -------------
State C                             =        ------
a                                   =        --------
b                                   =        ---
c                                   =        ---
d                                   =        -----
e                                   =        -----
Bill                                =        -------------------------------------
Facility A                          =        -------------
Facility B                          =        ----------
Location                            =       -------------------------------------------------------------------------
                                             --------------------------------------------
PLR-112343-21                                   2

Date                        =      ------------------
Year A                      =      -------
Year B                      =      -------
Year C                      =      -------

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

This letter responds to your request, dated May 28, 2021, 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

S1 and S2 (hereinafter S1 and S2 will collectively be referred to as Taxpayer), State A
corporations, are public utilities serving retail electric customers in State A. Taxpayer is
wholly owned by S3, a State A energy holding company. S3 is wholly owned by
Company, a State B limited liability company that is disregarded for federal income tax
purposes and wholly owned by S4, a State C corporation. S4 is a percent owned by P,
a State B corporation. P and its affiliated group of corporations, including Taxpayer, S3,
and S4, file a consolidated federal income tax return on a calendar year basis using the
accrual method of accounting.

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, as established by Commission A, 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. 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 utility’s rate base
and expenses associated with such REF must be excluded from the utility’s revenue
requirement.

Pursuant to the requirements of Section 6 of Bill, Taxpayer intends to acquire Facility A
and Facility B (Facilities). S1 will own b percent and S2 will own c percent of each of
the Facilities. The Facilities are both located at Location. Facility A is a d-megawatt
PLR-112343-21                                 3

solar electric generating facility. Facility A is expected to begin commercial operation in
late Year A or early Year B. Facility B is a e-megawatt solar electric generating facility.
Facility B is expected to go into commercial operation in Year B. The Facilities have
obtained their respective interconnection agreements with the transmission provider. A
portion of Facility A has substantially completed its permitting requirements at the
federal, state, and local level. Permit applications are pending for Facility B and the
remaining portion of Facility A. All permitting for the Facilities is expected to be
concluded by the end of Year C.

Taxpayer represents that the Facilities will satisfy the requirements of Section 6 of Bill.
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. The revenue to Taxpayer for the renewable energy
produced by the Facilities will be the price charged to customers based on competitive
market rates and will not be based on cost-of-service or rate-of-return ratemaking
principles.

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 6 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.

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-112343-21                                   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-112343-21                                 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.

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 Section 6
of 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 Section 6 of Bill by which
Taxpayer can charge rates to State A customers does not include recovery of
Taxpayer’s costs on a cost-of-service, rate-of-return basis, and all costs, including any
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
Section 6 of 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
       § 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 6 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
PLR-112343-21                                 6

       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.

This letter is being issued electronically in accordance with Rev. Proc. 2020-29, 2020-
21 I.R.B. 859. A paper copy will not be mailed to Taxpayer.

In accordance with the power of attorney on file with this office, we are sending a copy
of this letter to your authorized representative. We are also sending a copy of this letter
to the LB&I Policy Office.



                                       Sincerely,



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



Enclosure:
Copy for § 6110 purposes



cc: