How did the former Texas franchise tax treat an electric utility LLC's transition-property transactions and interest received by its bondholders?

Plain-English summary

The utility LLC's transition-property transactions and transition charges were excluded from the former franchise-tax bases, while taxable bondholders treated their interest as a non-Texas gross receipt.

An electric utility proposed forming a wholly owned Delaware LLC qualified to do business in Texas. The LLC would issue bonds secured by transition property, pay the bond proceeds to the utility, receive transition charges, temporarily invest charge proceeds, and maintain reserve accounts under the bond indenture. It would conduct no other business and would dissolve when the bonds were retired.

The Comptroller applied Section 39.311 to exclude the described transfer and ownership of transition property and receipt of transition charges from the LLC's taxable capital and taxable earned surplus.

The letter separately addressed the bondholders. Interest received by a bondholder subject to Texas franchise tax was a gross receipt. Because the issuer was organized in Delaware, the interest was a non-Texas gross receipt included in the denominator of the Texas apportionment factor.

The body identifies temporary-investment and reserve-account income as LLC revenue but does not expressly state its tax treatment. This page does not infer an answer from other rulings.

Currency note: Texas replaced the taxable-capital and earned-surplus franchise tax with the margin tax effective January 1, 2008. Confirm current Section 39.311 and apportionment law.

What this means for you

Electric-utility securitizations

The express exclusion covered transition-property transactions and transition charges authorized under the financing-order structure described in the letter.

Bondholders

Under the former apportionment rules, the issuer's Delaware organization made the bond interest a non-Texas gross receipt for a bondholder subject to the tax.

Common questions

Q: Did the LLC include transition charges in taxable capital or earned surplus?
A: No. The letter excluded the described transactions and charges from both bases.

Q: How was bond interest sourced?
A: As a non-Texas gross receipt because the issuer was organized in Delaware.

Q: Did the letter exempt the LLC's reserve-account earnings?
A: It does not expressly answer that question.

Citations and references

• Senate Bill 7, 76th Legislature, Chapter 39, Subchapter G
• Section 39.311 - transition-property and transition-charge treatment

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200001271L

Original ruling text

January 11, 2000

Dear **:

You have requested a ruling regarding the applicability of Texas franchise tax
to a proposed transition property securitization transaction undertaken
pursuant to Senate Bill 7, passed by the 76th Legislature.

Senate Bill 7 (the "Act") provides for the restructuring of the electric
utility industry and sets forth provisions for the industry's transition from a
regulated to a competitive electric market. Pursuant to Chapter 39, Subchapter
G, of the Act, electric utilities may request the Public Utility Commission to
adopt a financing order allowing the utility to impose transition charges to
recover its stranded and other costs and regulatory assets. An electric
utility's rights under such a financing order, including the right to impose,
collect, and receive transition charges authorized in the order, may be
transferred to an assignee or pledged to secure financing; the transferred or
pledged rights become "transition property."

The Act specifically provides that transition property constitutes a present
property right for purposes of contracts concerning the sale or pledge of
property. Pursuant to a financing order, an electric utility or its assignee
may issue transition bonds that are secured by or payable from transition
property. The transition bonds are retired by use of proceeds from the
transition charges.

TP (the electric utility) proposes to create a Delaware limited liability
company qualified to do business in Texas, of which TP will be the sole member
("TP-LLC"). Over a period of time, TP-LLC will issue one or more series of
bonds secured by the transition property and will remit the bond proceeds to TP
in payment for the transition property.

TP-LLC will have the following sources of income: (i) the transition charges;
(ii) interest and dividend income generated through the temporary investment of
the transition charge proceeds from the time of collection until quarterly or
semiannual payments on the bonds; and (iii) interest and dividend income
generated through the investment of funds in reserve accounts created pursuant
to the bond indenture. The directors and officers of TP-LLC will serve for no
compensation.

TP-LLC will engage exclusively in the above-described transactions relating to
the securitization of the TP transition charges. In this regard, the gross
revenues of TP-LLC will consist solely of the transition charges and interest
and dividend income, as described above. The sole expenses of TP-LLC will
consist of debt service on the transition bonds and administration expenses.
Upon retirement of the bonds, TP-LLC will terminate its operations and
dissolve.

TP-LLC will be engaged solely in transactions involving the transfer and
ownership of transition property and the receipt of transition charges. You
have asked if TP-LLC will incur Texas franchise tax liability for taxable
capital or taxable earned surplus purposes.

The exemption from taxation provided in Section 39.311 expressly references
franchise tax and transactions involving the transfer and ownership of
transition property and receipt of transition charges within a financing order
of the Public Utility Commission. As such, it appears that transactions
involving the transfer and ownership of transition property and the receipt of
transition charges as described in Section 39.311 will be excluded from the
computation of taxable capital and taxable earned surplus for TP-LLC.

You have also asked if the interest received by the bondholders is subject to
Texas franchise tax. The interest received by a bondholder subject to Texas
franchise tax would be a gross receipt. Based on the fact that TP-LLC is
organized in Delaware, the interest would be a non-Texas gross receipt and
would be counted in the denominator of the Texas franchise tax apportionment
factor.

This response is based on the facts presented in your letter. If the facts
change or if there are additional relevant facts, the response may change.

Should you have further questions, please feel free to contact me.

Sincerely,

Teresa Comer
Tax Policy Division

cc: Karey W. Barton, Director of Tax Policy
Bryant Lomax, Manager, Tax Policy