In Notice 2016-36, the IRS provides a safe harbor under which the transfer of an intertie to a regulated public utility, used to facilitate the transmission of electricity over the utility's transmission system, will not be treated as a contribution in aid of construction (CIAC) or give rise to gross income under Section 118(a). Significantly, Notice 2016-36 consolidates the safe harbor requirements under the previous Notices and removes the requirement that the generator must have a long-term purchase contract or long-term interconnection agreement with the utility that constructs the upgrades. Because no long-term power purchase contract or long-term interconnection agreement is required under the new safe harbor, a generator (such as a solar or wind farm) may contribute an intertie to a utility that qualifies under the new safe harbor even if the generator is interconnected with a distribution system rather than a transmission system. This Notice also extends the safe harbor to transfers of interties from energy storage facilities to regulated public utilities.

Notice 2016-36 applies to transfers of interties made on or after June 20, 2016. Taxpayers, however, may rely on the safe harbor for qualifying transfers made before June 20, 2016.

Background

Electricity generators typically have not entered into long-term power purchase contracts with utilities outside of their service area and have not entered into long-term interconnection agreements with transmission systems that are not located within their neighboring transmission systems.

To avoid curtailment of power by Regional Transmission Operators (RTO's), an electricity generator in one region and a utility in a different region that owns a transmission system that will be affected by power delivered by the generator may now enter into an agreement in which the utility constructs upgrades to its transmission system. This will allow the utility to handle the electricity generator's new capacity, and the generator will reimburse the utility for the costs of the upgrades. Under the previous Notices, contributions of transmission system upgrades to neighboring transmission systems would not qualify under the former safe harbor.

Additionally, due to industry changes, energy storage is playing an ever increasing part in management of grid frequency. Standalone batteries connected to the grid can allow the grid to shed electricity and call it back in very short intervals to manage frequency as well as smooth the transition to other energy sources, such as wind and solar.

Section 118(b) requires utilities to include in income the value of any CIAC made for the provision of services by a utility to a customer or potential customer. CIAC contributions are distinguishable from qualifying facility contributions. In a CIAC contribution, the customer contributes property to the utility to facilitate the utility's sale of power to the customer, while in a qualifying facility contribution the qualifying facility contributes property to a utility to permit the utility's purchase of power from the qualifying facility.

In Notice 88-129, 1988-2 C.B. 541, amplified and modified by Notice 90-60, 1990-2 C.B. 345, and Notice 2001-82, 2001-2 C.B. 619, the IRS created a safe harbor under Section 118(b) for intertie contributions by a qualifying facility to a regulated public utility. Under that safe harbor, a utility will not realize income on the transfer of an intertie by a qualifying facility when the transfer is made exclusively with the sale of electricity by the qualifying facility to the utility under a long-term power purchase contract. The possibility that the intertie may be used in wheeling electricity does not cause the contribution to be treated as a CIAC.

Notice 2016-36 consolidates and updates the safe harbor requirements in Notices 88-129, 90-60 and 2001-82. Notably, the Notice removes the requirement that the electricity generator must have a long-term power purchase contract or long-term interconnection agreement with the utility that constructs the upgrades.

Updated Notice 2016-36 Safe harbor

Under Notice 2016-36, a contribution of an intertie, including a dual-use intertie, by a generator to a utility will not be treated as gross income under Section 118(a) or a CIAC under Section 118(b) if all of the following conditions are met:

— The generator may not purchase electricity from a utility, unless the purchase satisfies the 5% test.

— Ownership of wheeled electricity must remain with the generator before transmission onto the grid; the ownership requirement is deemed satisfied if title to electricity wheeled passes to the purchaser at the busbar on the generator's end of the intertie.

— The intertie cost is not included in the utility's rate base.

— The intertie will be used for transmitting electricity.

— The generator capitalizes the intertie cost as an intangible asset and recovers the cost using the straight-line method over a 20 year useful life. A utility generally may not claim depreciation or amortization deductions for the intertie, but may take depreciation deductions for the intertie if it is transferred or deemed transferred to the utility.

The 5% test is satisfied if the utility reasonably projects that, during the 10 tax years of the utility beginning with the year in which the contributed intertie is placed in service, no more than 5% of the projected total power flows over the intertie will flow to the generator.

The safe harbor will terminate if one of the following events occurs:

— If, for any three tax years within a period of five consecutive tax years, more than 5% of the total power flows over the intertie flow from the utility to the generator, the generator will be deemed to have made a transfer to the utility that is a CIAC under Section 118(b) as of the last day of the third tax year. The "proportionate disqualification" does not apply to any property necessary for, and used solely to facilitate, the transmission of power by the generator to the utility.

— If a power purchase contract between a generator and utility terminates and the utility obtains or retains ownership of the intertie, the generator will be deemed to have transferred the intertie to the utility as of the first day of the termination. The deemed transfer will not be treated as a CIAC, except when circumstances show the parties' intention to characterize a contribution of an intertie as a transaction that in substance is a CIAC.

Notice 2016-36 includes a number of examples to illustrate these termination events.

Change in accounting method

A change to or from the safe harbor is an accounting method change to which Section 446 applies. A utility that wants to change its accounting method to adopt the safe harbor in Notice 2016-36 must use the automatic change procedural rules in Revenue Procedure 2015-13, 2015-5 IRB 419, or its successor. The eligibility rules in Sections 5.01(1)(d) and (f) of Revenue Procedure 2016-29 do not apply to a utility making a change to (or from) the safe harbor in Notice 2016-36. Presently, Revenue Procedure 2016-29 is modified to include new section 15.16 for the application, or termination, of the safe harbor in Notice 2016-36 and the designated change number is 226. The change in accounting method under Section 15.16(1)(a) (change to use the new safe harbor) of Revenue Procedure 2015-13 is made with a Section 481(a) adjustment.

Implications

In summary, the impetus for consolidation and expansion of the safe harbor is to address industry changes and regional implications of interconnecting to the grid. Since the issuance of the prior Notices, electricity transmission and distribution systems have evolved and become interlinked so that close coordination of operations within the major U.S. power grids is needed to maintain the various interlinked components.

Utilities across geographic regions interconnect for improved reliability and efficiency. Utilities can draw power from generator reserves in different regions to ensure continuing, reliable power and to diversify their loads. Interconnection also provides access to cheap bulk energy by allowing utilities to receive power from different sources. Further, through greater coordination, utilities can help one another maintain the frequency of oscillation of alternating current and manage interconnections between utility regions. The Treasury Department and the IRS believe the new modifications set forth in Notice 2016-36 will help promote reliability and economic efficiency throughout the grid and the development and interconnection of renewable energy sources.

A taxpayer wishing to avail itself of the safe harbor should carefully review the provisions of Notice 2016-36 to help ensure qualification under the new safe harbor as well as the accounting method change provisions to procedurally adopt the safe harbor for all qualifying transfers of an intertie.

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