On June 10, 2016, the IRS released Notice 2016-36, which updates and expands the safe harbor provisions for payments and transfers of property to regulated public utilities occurring after June 20, 2016. Although the utility must pay taxes on most payments or other contributions that a customer or project developer may make to upgrade the utility’s equipment for new services or generator interconnection, the IRS is exempting projects that it classifies as facilitating the transmission of electricity over the utility’s transmission system. Specifically, the IRS considers contributions by Qualifying Facilities, wind generators, solar generators and energy storage to be such projects. As of June 20, 2016, payments or transfers of those types of projects will be treated as a contribution to the capital of a corporation and not a taxable contribution in aid of construction (a “CIAC”). The Notice modifies and supersedes Notice 88-129, 1998 C.B. 541; Notice 90-60, 1990-2 C.B. 345; and Notice 2001-82, 2001-2 C.B. 619 (the “Prior Notices”).
By way of brief background, § 61(a) the Internal Revenue Code (the “Code”) provides that gross income means all income from whatever source derived, unless excluded by law. Section 118(a) of the Code provides that in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. Section 118(b) of the Code provides that for purposes of § 118(a), the term “contribution to the capital of a taxpayer” does not include any CIAC or any other contribution as a customer or potential customer.
The Prior Notices provided guidance with respect to the treatment of payments and transfers of property to regulated public utilities by qualifying small power producers and qualifying cogenerators (collectively, “Qualifying Facilities”). Specifically, the Prior Notices provided that a payment or transfer of property by a Qualifying Facility to a utility, with which it has a long-term power purchase contract or long-term interconnection agreement, would not constitute a taxable CIAC under either of the following safe harbor provisions: (i) the payment or transfer of property was made exclusively to promote the sale of electricity by the Qualifying Facility to the utility; or (ii) in the event the payment or transfer of property was not made exclusively to promote the sale of electricity by the Qualifying Facility to the utility, such as in the case of a “dual-use intertie,” then provided that the payment or transfer of property satisfied the “5% test.” The 5% test was satisfied if it was reasonably projected that during the ten taxable years of the utility beginning with the taxable year in which the transferred intertie was placed in service, no more than 5% of the projected total power flows over the intertie would flow to the Qualifying Facility.
The IRS issued Notice 2016-36 after recognizing that since the issuance of the Prior Notices, “electricity transmission and distribution systems have evolved and become interlinked so that close coordination of operations with the major U.S. power grids is needed to maintain the various interlinked components.” In order to appropriately adjust tax policy to reflect these industry changes, Notice 2016-36 modifies and supersedes the Prior Notices by (i) consolidating the safe harbor provisions of the Prior Notices, and (ii) providing new safe harbor provisions that remove the requirement that the Qualifying Facility have a long-term power purchase contract or long-term interconnection agreement with the utility. The IRS recognized that due to the substantial interlinking of the electricity distribution systems in the United States, a Qualifying Facility in one region and a utility in a different region that owns a transmission system that will be affected by power delivered by the Qualifying Facility may enter into an agreement in which the utility constructs upgrades to its transmission system, allowing it to handle increased capacity caused by the Qualifying Facility, and the Qualifying Facility may reimburse the utility for the costs of the upgrades. Although these entities may not have reason to enter into a power purchase contract or long-term interconnection agreement, the payment or transfer of property from the Qualifying Facility to the utility will promote reliability and economic efficiency throughout the grid and therefore may be warranted. Prior to the issuance of Notice 2016-36, however, such payment or transfer of property would have constituted a taxable CIAC under § 118(b) of the Code.
The IRS also took notice of the increased importance of renewable energy sources and their impact on the transmission and distribution of power throughout the United States. As a result, Notice 2016-36 also extends the provisions of the safe harbor to payments and transfers of property from solar and wind generators as well as energy storage facilities.
The updated safe harbor provisions are a welcome change and reflect new marketplace realities. If you have questions about Notice 2016-36 or the updated safe harbor provisions, please contact us.
By: Andrew S. Rusniak, Esq.