In PLR 202017027, the IRS ruled that a facility that generates solar electricity will not be public utility property (PUP) under IRC Section 168(i)(10) and former IRC Section 46(f)(5).

The IRS based its ruling on the finding that the prices negotiated with customers under solar energy service agreements are market based, and not at cost-of-service based, rate-of-return prices for the furnishing of electricity.

Facts

Company is a public utility that produces electricity and is a disregarded entity of Taxpayer. The applicable regulatory commission granted Company's request to implement an energy services program (Program) using market-derived pricing for solar energy services. Under the Program, Company will enter into a solar energy service agreement with participating customers to provide solar energy services through a solar photovoltaic generation system (System) to be constructed and installed on the customers' premises. Company will own, operate and maintain the system, and customers will receive a percentage of the electrical energy generated by the System for a fixed monthly fee, which could include a fixed percentage price escalator.

Customers' rates will be based on market-based prices for the particular solar facility that each participating customer selects.

Law and analysis

IRC Section 168(i)(10) defines PUP 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.

Under IRC Section 168(f)(2), a depreciation deduction determined under IRC Section 168 does not apply to any PUP if the taxpayer does not use a normalization method of accounting.

The regulations under former IRC Section 46, specifically Treas. Reg. Section 1.46-3(g)(2), define the regulated rates as those established or approved on a rate-of-return basis.

The IRS said a facility must have three characteristics to qualify as PUP:

• It must be predominantly used in the trade or business of furnishing or selling electricity.
• The rates for the sale must be established or approved by one of the listed agencies or instrumentalities.
• The rates must be established on a rate-of-return basis.

The IRS said any facility in the Program will satisfy the first two characteristics. The facilities would not, however, satisfy the third characteristic because prices would be determined on a market basis (i.e., prices under the solar energy service agreement will be set at arm's-length under a request for proposal (RFP) provided to Company by the facility's developer and the facility would sell electricity to Company under a wholesale solar energy service agreement).

The IRS declined to express an opinion on: (1) whether the contract to sell electricity constitutes a service contract under IRC Section 7701(e); (2) whether the Taxpayer owns the system generating electricity for federal income tax purposes; and (3) the classification of the property under IRC Section 168(e).

Implications

This is another ruling highlighting a general demand and preference by regulated utilities to own renewable assets outright, rather than engage in power purchase agreements with independent power producers.

This ruling is similar to an earlier one that said the property (wind in that case) is not PUP and therefore not subject to normalization rules because the rates being charged are market based and not cost-of-service/rate-of-return regulated rates (see Tax Alert 2019-2080).

A key takeaway from this ruling is that companies continue to evaluate structures that will facilitate the inclusion of renewables in their regulated operations at competitive prices. That said, care must be taken to navigate the normalization rules when considering adding renewable energy property in regulated operations.

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