Energy Tax Law Alert: IRS Rules That Payment for Intertie Constitutes Taxable Contribution in Aid of Construction

The IRS has issued a private letter ruling concluding that the reimbursement by a solar electric generator of an electric distribution company’s costs to construct an intertie is a contribution in aid of construction under Section 118(b) of the Internal Revenue Code (the Code) and is not excludable from the gross income of the distribution company as a non-shareholder contribution to capital under Section 118(a) of the Code.

The distribution company entered into an interconnection agreement with a generator with respect to the generator’s solar electric generation facility (the “Interconnection Agreement”). Pursuant to the Interconnection Agreement, the distribution company agreed to construct an intertie to connect the facility to the electric grid system and the generator agreed to pay for the cost of construction of the intertie. The distribution company holds legal title to the intertie and the intertie is a permanent part of the distribution company’s electric distribution system. All of the electricity generated by the facility is sold to a third party pursuant to a power purchase agreement. Following the sale of electricity to the third party, the electricity passes through the distribution company’s intertie and is delivered to its distribution system; there is no direct interconnection between the facility and the electric transmission system.

The taxpayer requested a ruling that the generator’s payments to construct the intertie do not constitute a contribution in aid of construction under Section 118(b) of the Code and are excludable from gross income as a nonshareholder contribution to capital under Section 118(a) of the Code.

Generally, 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,” including contributions to capital by people other than shareholders. However, Section 118(b) of the Code provides that the term “contribution to the capital of taxpayer” for this purpose does not include any contribution in aid of construction or any other contribution as a customer or potential customer.

With respect to contributions of interties by generators of electricity, in Notice 88-129, as modified and amended by Notice 90-60, and Notice 2001-82 (collectively, the “Notices”), the IRS concluded that transfers of interties to regulated public utilities by qualifying (as defined in section 3 of the Federal Power Act, as amended by section 201 of the Public Utilities Regulatory Policies Act of 1978) and non-qualifying small power producers and cogenerators are not contributions in aid of construction and do not give rise to income to the utilities. In addition to several other factors, the Notices contemplated that the facilities were directly interconnected to the electric transmission system.

In analyzing the taxpayer’s ruling request, the IRS concluded that the Notices did not apply because there is no direct interconnection between the facility and any electric transmission system. Furthermore, the IRS concluded that the contribution by the generator does not satisfy the requirements for a non-shareholder contribution to capital as developed through case law. Accordingly, the IRS concluded that the payment by the generator to construct the intertie is income to the distribution company.

A private letter ruling may be relied upon only by the taxpayer that requested the ruling and may not be used or cited as precedent. However, private letter rulings do provide insight on how the IRS views the issues addressed therein.

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