November 28, 2022
IRS rules again that solar facility is not public utility property
In PLR 202247006, the IRS ruled that a solar energy facility will not be considered public utility property (PUP) because its rates are fixed and not determined on a cost-of-service, rate-of return basis.
Taxpayer is a public utility that sells electric energy with rates regulated by Commission. Solar JV, a subsidiary of Taxpayer, entered into an agreement with a third-party developer to acquire an interest in Project Company, which is developing a photovoltaic solar-powered electric generating facility (Facility). Taxpayer expects that Facility will qualify for the investment tax credit (ITC). Taxpayer and Tax Equity Investor will enter into a joint venture to own Project Company and convert Solar JV to a partnership. Taxpayer and Tax Equity Investor will each contribute cash to Solar JV, and Taxpayer will have the option to purchase all of Tax Equity Investor's interests in Solar JV for fair market value. Solar JV will own Project Company when Facility is completed. Commission is expected to allow Project Company to sell electricity at market-based rates, instead of cost-based rates with a regulated rate of return.
Project Company will sell electricity directly to Operator at market prices. Taxpayer and Operator will have a contract for differences (CFD) between a fixed rate and the market rate. The CFD will provide an economic hedge for the Facility so Project Company will receive a fixed price for its energy.
Taxpayer asked the IRS to rule that (1) Facility is not PUP under IRC Section 168(i)(10) and is not subject to the ITC normalization rules, so depreciation deductions and investment tax credits will not be subject to the normalization rules under IRC Section 168(i) or former IRC Section 46(f), and (2) neither Taxpayer nor Tax Equity Investor are subject to the normalization rules as a result of their interests in Solar JV.
Law and analysis
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 from use of different methods and periods of depreciation are only logical in the context of rate-of-return regulation.
The IRS said a facility must have three characteristics to qualify as PUP:
The IRS said Facility satisfied the first two requirements. Facility failed, however, to satisfy the third requirement because Project Company will use Facility to sell its energy at rates established on a market basis (and not on a rate-of-return or cost basis).
The IRS also ruled that neither the Taxpayer nor the Tax Equity Investor are subject to the ITC normalization rules under IRC Section 168(i) or former IRC Section 46(f).
The IRS noted that it was not addressing whether Solar JV would be a partnership or ineligible under IRC Section 761 to elect out of partnership treatment.
This ruling, along with others, continues to show the path forward for utilities that wish to invest in renewable energy projects but are concerned about trying to be cost competitive with independent power producers that are not subject to the normalization rules.
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor