21 November 2019 Wind power facility does not meet public utility property requirements In a private letter ruling (PLR 201946007), the IRS ruled that a wind power facility is not public utility property (PUP) under IRC Section 168(i)(10). Although the facility possessed several characteristics of PUP, the power will be sold under a power purchase agreement with prices established at market rates and not on a rate-of-return basis or cost basis. The IRS declined to rule on the issue of whether IRC Section 707(b) would disallow any losses that the electricity company allocated to a tax equity investor. Corporation, through a limited liability company (Company), planned to replace a substantial portion of its coal-fueled electric generating fleet by investing in and purchasing electricity from wind projects. Company entered into a joint venture with Tax Equity Investor to form Wind JV, which will buy all the assets of the developer building a wind project (Facility). Facility will generate electricity to sell to Company under a power purchase agreement (PPA). The Wind JV transaction and the PPA are subject to approval by the first utility commission, which participates in a wholesale energy market regulated by the second utility commission. The PPA is a "wholesale PPA" under the market-based rate authority of the second utility commission. The prices under the PPA will be determined on a market basis, using a competitive bidding process, and will not be determined on a rate-of-return basis or cost basis. Company will include electricity purchased from Wind JV as part of its delivery of electricity to retail customers, the sale of which will be regulated by the first utility commission. After two years, Company will have the option to purchase all of Tax Equity Investor's interests in Wind JV for fair market value. If Wind JV is then wholly owned by Company, the electricity generated by Facility will continue not to be subject to rate-of-return or cost basis regulation by the first utility commission. IRC Section 168(i)(10) defines public utility property as property used predominantly in the trade or business of furnishing or selling electrical energy if the rates for furnishing or selling have been established or approved by a state or political subdivision. Treas. Reg. Section 1.46-3(g)(2) defines the regulated rates as those established or approved on a rate-of-return basis. Depreciation under IRC Section 168 will not apply if the utility does not use the normalization method of accounting. 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.
While Facility possessed the first two characteristics, the IRS noted that it did not possess the third. The IRS said Facility satisfied the first requirement because it would be predominantly used in the furnishing or sale of electricity. The IRS said Facility satisfied the second requirement because it would be regulated by the second utility commission. Facility did not, however, satisfy the third requirement; because prices under the PPA will be set at arm's length under an RFP provided to Company by Facility's developer, Facility would sell electricity to Company under a wholesale PPA, so the prices would be determined on a market basis, not a rate-of-return basis or cost basis. The IRS said it could not rule on whether IRC Section 707(b) would disallow losses of Wind JV allocated to Tax Equity Investor (certain sales or exchanges of property with respect to controlled partnerships) because the IRS cannot issue a private letter ruling "if the request presents an issue that cannot be readily resolved before a regulation or any other published guidance is issued." As the demand for renewable energy continues to grow, utility companies are increasingly interested in owning such facilities, but continually face the challenge of becoming price competitive to facilitate direct ownership of renewable assets. The normalization rules limit how quickly public utilities can pass the benefits of accelerated depreciation and investment tax credits through to their customers in the terms of lower rates. This limit puts public utilities at a competitive disadvantage to independent power producers (IPPs), which are not subject to such limitation when it comes to the electricity pricing. As a result of this limitation, utilities often enter into PPAs with IPPs so the utilities are not subject to the normalization rules. Based on the facts of this PLR, the market-based PPA resulted in the facility not being considered PUP and therefore not subject to the normalization rules. We've now seen several instances where utility companies have used market-based pricing to avoid having a renewable facility be considered PUP. The rulings that based their conclusions on market-based pricing of the power contracts have yet to address the more specific question some utilities and tax investors are currently exploring: If a renewable facility in a tax equity partnership were to be considered PUP (i.e., the utility would include its investment in the facility joint venture in the rate base and recover it from customers on a cost of service/rate-of-return basis), would the partnership allocation of the tax attributes be respected between the utility and the tax equity investor? In other words, would application of a normalization method of accounting be limited to the tax items allocated only to the regulated utility? In an environment where many regulated utilities are looking to achieve ambitious growth goals that include increasing renewable energy, accessing tax equity capital within the regulated investment and recovery model may be the more direct path to leveling the playing field.
Document ID: 2019-2080 | |||||||||
